INTRODUCTION 
To  ECONOMICS 


GHAHAH  A.  LAING 


AN    INTRODUCTION    TO 
ECONOMICS 


BY 


GRAHAM  A.   LAING,  M.A. 

FORMERLY    INSTRUCTOR    IN    ECONOMICS    AND    HISTORY 
UNIVERSITY    OF    CALIFORNIA 


THE  GREGG  PUBLISHING  COMPANY 

NEW  YORK          BOSTON          CHICAGO          SAN  FRANCISCO 
ENGLAND:  21  HARRINGTON  STREET,  LIVERPOOL 


COPYRIGHT,     1919,     BY     THE 
GREGG    PUBLISHING    COMPANY 


PREFACE 

THIS  book  is  designed  as  an  introductory  treatise  on 
the  science  of  Economics.  In  its  preparation  the  author 
has  had  constantly  in  mind  the  demands  of  secondary 
schools  for  a  textbook  that  lays  stress  upon  the  dis- 
cussion of  economic  principles  with  especial  reference 
to  American  conditions. 

Two  aims  have  been  followed.  First,  to  give  a  work- 
ing basis  in  the  knowledge  of  the  methods  and  terms 
to  be  used,  and  of  the  content  of  the  subject,  such  as 
society  as  a  developed  organism,  the  laws  of  produc- 
tion, the  methods  and  organization  of  production  and 
exchange.  The  growth  of  productive  methods  from 
the  time  of  communal  working,  through  domestic 
manufacture  to  the  factory  system,  has  been  carefully 
discussed.  This  discussion  shows  how  manufacturing 
has  developed  from  small  units  with  hand  labor  to 
production  on  a  large  scale  by  machinery,  which  has 
resulted  in  the  very  large  increase  in  trades  and  in- 
dustries. The  meaning  of  the  terms  production  and 
value,  and  the  laws  which  govern  the  production  of 
commodities,  have  been  carefully  explained. 

The  second  aim  has  been  to  present  the  methods 
employed  in  the  application  of  economic  principles, 
with  especial  reference  to  exchange.  In  dealing  with 
the  banking  system,  for  example,  a  comprehensive 
account  is  given  of  the  Federal  Reserve  System  which 


2033727 


iv  PREFACE 

has  played  so  important  a  part  in  the  commercial 
organization  of  the  United  States  during  the  past  few 
years.  Banking,  as  a  general  subject,  has  been  con- 
sidered from  the  point  of  view  of  its  function  rather 
than  of  its  technique. 

Because  of  the  importance  of  international  trade  in 
the  future  economic  development  of  American  industry, 
careful  attention  has  been  given  to  the  principles  in- 
volved, as  well  as  to  the  closely  related  subject  of 
foreign  exchange. 

Throughout  the  book  emphasis  has  been  placed  on 
the  fact  that  all  economic  organization  and  industry 
are  only  a  means  to  an  end,  and  that,  therefore,  the 
welfare  of  those  who  carry  on  production  must  be  given 
consideration.  Labor  problems  have  been  treated 
without  bias,  as  have  also  the  suggestions  for  the  re- 
construction of  society.  Exhaustive  treatment  of  these 
subjects  in  a  textbook  of  this  kind  is  impossible,  but  it 
is  hoped  that  the  student  will  feel  that  he  has  sufficient 
basis  on  which  to  build  a  real  knowledge  of  those  prob- 
lems with  which  he  will,  later  on,  be  called  upon  to  deal. 

Thanks  are  due  to  Professor  Solomon  Blum  of  the 
University  of  California  for  his  interest  and  kindness 
in  reading  the  manuscript,  and  to  Professor  F.  R. 
Macaulay,  for  helpful  suggestions  and  criticisms. 

GRAHAM  A.  LAING 

BERKELEY,  CAL. 
May,  1919. 


CONTENTS 

CHAPTER  I 

THE   MEANING   OF   ECONOMICS 

•    PAQE 

Statement  of  the  Problem  of  Living  —  Definition  of  Economics  — 
Economics  a  Social  Science  —  The  Subject  Matter  of  Economics 
—  Economic  Laws  —  The  Deductive  Method — The  Syllogism  — 
The  Inductive  Method  —  Value  of  Economic  Laws  —  The  Scope 
of  Economics  —  Summary 1 

CHAPTER  II 

THE  THEORY  OF  ECONOMIC  DEVELOPMENT 

Economic  History  —  The  Four  Stages  of  Development  —  Definition 
of  Economic  Unit  —  Characteristics  of  Development  —  Relations 
between  the  Stages  of  Development  —  Variations  in  Rate  of  De- 
velopment —  Modern  Civilization  Dynamic  —  Growth  of  Civiliza- 
tion Accompanied  by  Increase  in  Needs  of  Man  —  Physical 
and  Conventional  Necessities  —  The  Economic  Problem  .  .  15 

CHAPTER  III 

THE    COMPETITIVE    SYSTEM 

Economic  Freedom — Regulation  of  Industry  —  Production  for  Profit 
Most  Satisfactory  System  —  Basis  of  Argument  in  Favor  of  Pro- 
duction for  Profit  —  Limitation  to  Demand  for  Necessities  —  The 
Idea  of  Competition  —  Meaning  of  Competition  —  Labor  Viewed 
as  a  Commodity  —  Claims  Made  for  the  Competitive  System  — 
Some  Defects  of  the  Competitive  System  —  Failure  of  Competi- 
tion —  Change  in  Principle  of  Government  Regulation  —  Sum- 
mary   26 

CHAPTER  IV 

THE   MEANING    OF   PRODUCTION 

Physical  and  Conventional  Necessities  —  Characteristics  of  Civili- 
zation —  Meaning  of  the  Term  Wealth  —  Wealth  Comprises 
Services  as  well  as  Material  Goods  —  Utility,  Distinguished 
from  Usefulness  —  Consumption  of  Utilities  —  Production  De- 


CONTENTS 


PAOE 


termined  by  Consumption  —  Definition  of  Production  —  The 
Miner  as  a  Producer  -  The  Steel  Manufacturer  -  The  "Produc- 
tion" of  a  Ship  —  Agriculture  as  Production  —  Production  of 
Utilities  —  Summary 

CHAPTER  V 

THE   AGENTS  OF   PRODUCTION 

Meaning  of  the  Word  Land,  as  an  Agent  of  Production  —  Meaning 
of  Labor  —  Meaning  of  Capital  —  Capital  and  Consumers 
Wealth  —  Classification  of  Forms  of  Capital  —  Circulating  and 
Fixed  Capital  —  Division  of  Labor  under  Capitalistic  System  — 
Scientific  Labor  —  Specialization  in  Location  of  Industry  .  .  55 

CHAPTER  VI 

THE   LAWS   OF   PRODUCTION 

Production  Stimulated  by  Profits  —  Production  Secured  through  Ap- 
plication of  Capital  and  Labor  to  Natural  Resources  —  Necessity 
for  a  Certain  Minimum  Capital  and  Effects  of  Increases  — 
The  "Dose"  of  Capital  and  Labor— Law  of  Increasing  Re- 
turns —  Illustration  from  Ship-building  Industry  —  Law  of  Di- 
minishing Returns  —  Graphic  Illustration  —  Effect  of  the  Opera- 
tion of  the  Laws  of  Increasing  and  Diminishing  Returns  .  .  66 

CHAPTER  VII 

THE    ORGANIZATION   OF   PRODUCTION 

Distinction  between  Business  and  Industry  —  Early  Trade  —  Mer- 
chant Fleets  —  Formation  of  Partnerships  and  Companies  — 
Monopolies  and  Regulated  Companies  —  The  Chartered  Com- 
panies —  Advantage  and  Defects  of  Partnerships  —  Early  Joint- 
stock  Companies  —  Limited  Liability  —  Government  of  the 
Modern  Corporation  —  Bond  Issues  and  Bondholders  —  Profits 
of  Bond-  and  Stockholders  —  Improvements  in  Production 
Due  to  Corporation  Form  of  Organization  —  Illustration  from 
Banking  Business  —  Department  and  Chain  Stores  ...  77 

CHAPTER  VIII 

THE   ORGANIZATION   OF   PRODUCTION    (continued) 

Agriculture  as  Industry  —  Primitive  Agriculture  —  Communal  Till- 
age —  Difficulties  in  the  Way  of  Progress  —  Extensive  Culture  in 
America  —  Increased  Use  of  Fixed  Capital  —  Manufactures. 
Subordinate  Nature  of  Early  Manufacture  —  The  Gild  System  — 
Manufacture  on  a  Small  Scale  —  The  Factory  System  —  In- 
creased Use  of  Fixed  Capital  in  Manufacture  —  Complexity  of 
Modern  Trade  Forms  —  Elimination  of  Waste  —  Problems  of 
Production 91 


CONTENTS  vii 

CHAPTER  IX 

THE    ORGANIZATION    OF    CAPITAL 

PAGE 

Failure  of  Competition  —  Limitation  of  Competition.  1.  The  Cor- 
poration 2.  Price  Agreements  —  Example  of  Price  Agreement. 

3.  The  Kartel      4.    The  Pool      5.   Monopolies      6.    The    Trust 
7. .  The    Holding     Company  —  Uniform     Object     to     Eliminate 
Competition  —  Effects  of  Monopoly  Organization  —  Control  of 
Monopolies  —  Justification  of  Monopolies 106 

CHAPTER  X 

VALUE 

Meaning  of  the  Term  Value  —  Diminishing  Utility  —  Marginal 
Utility  —  Present  and  Future  Satisfaction  —  Effective  Demand 

—  Meaning  of  Price  —  Relations  between  Supply  and  Demand, 

and  Price  —  Elasticity  of  Demand 120 

CHAPTER  XI 

THE   LAW   OF   SUPPLY   AND   DEMAND 

The  Factors  of  Exchange  —  Strong  and  Weak  Buyers  and  Sellers  — 
The  Demand  Curve  —  Consumer's  Surplus  —  The  Supply  Curve 

—  Producer's    Surplus  —  Market    Price  —  Definition    of    Term 
Market  — Limits  of  Price  Fluctuation  —  Normal  Price — The  Flow 

of  Capital 133 

CHAPTER  XII 

MONOPOLY  AND  MONOPOLY  PRICE 

Importance  of  Stability  of  Prices — Varieties  of  Monopolies  —  Monop- 
olies by  Royal  Grant  —  Patents  and  Copyrights  —  Trade  Marks  — 
Monopoly  of  Location  —  Necessity  of  Control  of  Production  and 
Distribution  —  Definition  of  Monopoly  —  Factors  in  Determina- 
tion of  Monopoly  Price  —  Latent  Competition  —  Elasticity  of 
Demand 149 

CHAPTER  XIII 

THE    EVOLUTION    OF   MONEY 

Problems  of  Barter  Exchange  —  Cattle  Used  as  Money  —  Other  Forms 
of  Money  —  The  Qualities  Desirable  in  a  Money  Material  — 
1.  Value  in  use  2.  Universal  Acceptability  3.  Divisibility 

4.  Homogeneity       5.   Portability       6.    Durability       7.    Stability 
8.   Cognizability — Metals  as  Money — Remedies  for  Defects  in 
Metallic  Money  —  Coined  Money  —  Definition  of  a  Coin  —  De- 
basement of  Coinage  —  Effects  of  Depreciated  Coinage    .  .160 


vfa  CONTENTS 

CHAPTER  XIV 

SOME   MONEY   PROBLEMS 

PAGE 

Seigniorage  -  Gresham's  Law  -  Subsidiary  Coinage  -Token  Money 
^-Bimetallism -Position  of  Silver  Dollars  -  United  States 
Currency -Money  and  Price  -  Relation  of  Gold  Supply  to 
Prices -Fluctuations  in  the  Demand  for  Currency  -  Elastic 
Currency -Effects  of  Issue  of  Fiat  Money  -  Currency  Infla- 
tion  —  Measurement  of  Prices.  Index  Numbers  .  .  .  J 

CHAPTER  XV 

THE   EVOLUTION   OF   THE   BANKING   SYSTEM 

Honesty  the  Basis  of  Economic  Structure  —  Banks  the  Lubricants  of 
Commerce  —  Beginning  of  the  Deposit  System  —  Bank  Notes. 
Origin  —  The  Deposit  System  —  Necessity  for  Bank  Deposit  Re- 
serves _  The  Case  of  Two  or  More  Banks  —  The  Clearing  House 

—  Debtor  and  Creditor  Banks  —  The  Bank  Loan  —  Accommo- 
dation Loans  —  Capital    Loans  —  Commercial  Loan  —  Discount 

—  Value  of  Discount  System  —  Bank  Notes         .        .        .         .190 

CHAPTER  XVI 

THE   AMERICAN   BANKING   SYSTEM 

The  National  Banks,  Early  History  —  National  Banking  Act. 
1.  Minimum  of  Capital  2.  Bond  Purchases  and  Note  Issues 
3.  Reserves  —  Bank  Examinations  —  Criticism  of  the  System 

—  National    Bank  Notes  —  Redemption    of  Notes  —  National 
Notes  as  Currency  —  Perverse  Elasticity  —  The  Reserve  System 

—  Defects  of  the  System  — The  Call  Loan  System  —  Reserves 
during  Crisis         .        .      •  .      •  .        .        .        .         •        •         •     206 

CHAPTER  XVII 

THE   AMERICAN   BANKING   SYSTEM    (continued) 

The  Federal  Reserve  Banks  —  Control  of  Reserves  by  Individual 
Banks  —  Use  of  the  Discount  Rate  —  Rediscounts  —  The  Federal 
Reserve  Act  —  The  Reserve  System  —  Rediscount  Market  — 
Crises  and  Panics  —  The  Discount  Rate  —  Currency  —  Federal 
Reserve  Notes 220 

CHAPTER  XVIII 

THE  FEDERAL  RESERVE  SYSTEM  CONTINUED,  WITH  A  NOTE  ON  THE 
CANADIAN    BANKING    SYSTEM 

Elasticity  of  Currency  —  Federal  Reserve  Bank  Notes  —  Summary  — 
^Note  on  the  Canadian  Banking  System 235 


CONTENTS  IX 


CHAPTER  XIX 

THE  NATURE  AND  MECHANISM  OF  TRADE 

PAGE 

The  Nature  of  Trade  —  The  Mechanism  of  Exchange  —  The  Trade 

Acceptance 247 

CHAPTER  XX 

INTERNATIONAL   TRADE 

Meaning  of  the  word  International  —  Definition  of  Nation  —  Essen- 
tials of  International  Trade  —  Law  of  Comparative  Cost  —  Ben- 
efits of  International  Trade  —  Theory  of  International  Value 
—  International  Price  —  The  Cost  of  Transport  —  The  Equation 
of  Indebtedness 254 

CHAPTER  XXI 

DOMESTIC    AND    FOREIGN    EXCHANGE 

Difficulties  in  Paying  by  Check  —  Gold  or  Currency  Payments  — 
Payment  by  Draft  —  Mint  Par  of  Exchange  —  Method  of  Pay- 
ing for  Foreign  Goods  —  Finance  Bills  —  Effect  of  the  Time  Ele- 
ment on  the  Price  of  Exchange  —  Effects  of  the  Rate  of  Interest 
upon  Exchange  Rates  —  The  Causes  of  Gold  Movements  .  .  269 

CHAPTER  XXII 

PROTECTION   AND    FREE    TRADE 

Definitions  of  Protective  and  Revenue  Taxation  —  Effect  on  Prices  — 
Protection  of  Young  Industries  —  The  National  System  —  The 
Mercantilist  Argument  —  Cheap  Labor  —  Dumping  .  .  .  287 

CHAPTER  XXIII 

INVESTMENT    AND    SPECULATION 

The  Flow  of  Capital  —  Investment  —  Par  and  Investment  Price  — 
The  Future  Element  in  Business  —  Speculation  —  Stock  and 
Share  Investment  —  The  Method  of  Stock  Exchange  Specula- 
tion —  Grain  and  Produce  Speculation  —  Speculation  and  the 
Stability  of  Prices  —  Control  of  Speculation  .  .  .  .306 

CHAPTER  XXIV 

RENT,    INTEREST,    AND    PROFITS 

Distribution   as   an   Economic   Problem  —  Rent  —  Urban   Rents  — 

Quasi  Rents  —  Interest  —  Profits  —  Summary  Analysis       .         .     320 


x  CONTENTS 

CHAPTER  XXV 

THE   PERSONAL   DISTRIBUTION   OF   WEALTH 

PAQB 

Statistics  —  The  Present  Condition  —  The  Causes  of  Wealth. 
1.  Accidental  Causes  2.  Opportunity  3.  Efficiency  4.  Monopoly 
—  The  Causes  of  Poverty  —  Old  Age,  Sickness,  and  Death 
of  Chief  Wage  Earner  —  Unemployment  and  Irregular  Employ- 
ment -  Low  Wages  -  The  Incentives  to  Wealth.  1.  The  Will 
to  Live  2.  The  Acquisitive  Instinct  3.  Emulation  *•*** 
Will  to  Power  —  The  Incentives  to  Work  —  "The  Joy  of  Work- 
ing"—The  Creative  Instinct  — The  Organizing  Instinct  — 
The  Dominating  Instinct s 

CHAPTER  XXVI 

THE   REMUNERATION   OF   LABOR 

The  Meaning  of  the  Word  Labor  —  Labor's  Part  in  Production  — 
Labor  as  a  Commodity  —  Wage  Theories.  1.  The  Iron  Law  — 
Money  and  Real  Wages  —  The  Method  of  Payment.  1.  Time 
Wages  2.  Piece  Wages  3.  The  Bonus  Systems  4.  Profit 
Sharing 355 

CHAPTER  XXVII 

THE   ORGANIZATION   OF   LABOR 

The  Origin  of  Labor  Organizations  —  The  Right  to  Organize  —  The 
Methods  of  Organization  —  National  Association  —  The  Shop 
Steward  Movement  —  Aims  of  Labor  Organizations.  1 .  Collec- 
tive Bargaining  2.  Standard  Wage  3.  Conditions  of  Labor 
4.  Hours  of  Labor  —  Trade  Union  Methods  —  Arbitration  and 
Conciliation  —  The  Boycott  and  the  Union  Label  —  The  Success 
of  Trade  Unionism  .  370 

CHAPTER  XXVIII 

DISTRIBUTION   AND   THE   LABOR   PROBLEM 

Profit  Sharing  —  Co-operation  —  Co-operative  Production  —  Equality 

of  Taxation 389 

CHAPTER  XXIX 

THE  ECONOMIC  FUNCTIONS  OF  GOVERNMENT 

Protective  Functions  —  Regulative  Functions  —  Operative  Func- 
tions —  Government  or  Private  Ownership  of  Public  Utilities  — 
Lessons  of  the  War  —  Illustration  of  Government  Economic  Ac- 
tivity during  the  War 407 


CONTENTS  XI 

CHAPTER  XXX 

PROPOSALS  FOR  SOCIAL  RECONSTRUCTION 

PAGE 

Economic  Organization  a  Steady  Growth  —  Society  Dynamic,  not 
Static  —  Failure  of  Communistic  Experiments  —  Socialism  — 
Socialist  Criticisms  —  The  Central  Idea  of  Socialism  —  Revo- 
lutionary Socialism  —  State  Socialism  —  Objections  to  Social- 
ism —  Guild  Socialism  —  Conclusion 424 

BIBLIOGRAPHY      .  .     447 


AN  INTRODUCTION  TO  ECONOMICS 

CHAPTER  I 

THE  MEANING  OF  ECONOMICS 

Statement  of  the  Problem  of  Living  —  Most  of  the 
years  of  a  man's  life  are  occupied  in  the  solution  of 
the  pressing  problem  of  gaining  a  living.  There  is  no 
more  important  problem  to  solve,  and  the  fact  that 
it  is  always  solved  in  a  more  or  less  satisfactory  man- 
ner does  not  detract  from  its  importance.  In  all  ages 
and  places  the  provision  of  the  fundamentals  of  life  — 
food,  clothing,  and  shelter — has  been  a  paramount  con- 
sideration, more  pressing,  perhaps,  in  primitive  times 
when  man  lived  from  hand  to  mouth,  but  nevertheless 
essential  in  the  highest  civilization. 

But  the  problem  is  not  merely  to  gain  a  living  some- 
how :  it  is  to  gain  it  with  the  least  effort  and  in  the 
fullest  possible  degree.  Our  lives  are  fuller  and  more 
worth  living  than  those  of  the  earlier  inhabitants  of  the 
world  who  strove  wjth  the  primal  forces  of  nature. 
We  have  learned  to  subdue  nature,  to  understand  her, 
and  to  use  the  abundance  of  her  resources  to  a  greater 
extent  than  ever  formerly.  Yet  we  have  still  a  vast 
amount  to  learn.  We  have  not  yet  used  to  anything 
like  the  greatest  possible  degree  the  knowledge  that 
1 


2  AN   INTRODUCTION  TO  ECONOMICS 

our  scientists  have  gained  for  us.  Probably  the  bulk 
of  the  inhabitants  of  the  modern  world  still  live  from 
hand  to  mouth  as  did  their  prehistoric  ancestors, 
although  it  is  true  that  they  enjoy  many  advantages 
which  were  lacking  in  more  primitive  times. 

We  cannot,  therefore,  consider  the  problem  solved 
as  yet.  And  it  will  not  be  solved  unless  very  careful 
attention  is  devoted  to  the  study  of  the  best  means  of 
using  the  resources  of  the  earth.  Our  study,  therefore, 
resolves  itself  into  a  realization  of  the  fact  that  we 
are  in  possession  of  a  world  of  vast  possibility  in  the 
production  of  the  necessities  of  existence,  and  a  con- 
sideration of  the  best  means  by  which  these  possibilities 
may  be  made  actualities  not  only  to  a  few  individuals, 
but  to  all  the  inhabitants  of  the  world. 

Definition  of  Economics  —  Economics,  therefore, 
may  be  denned  as  the  study  of  man  in  regard  to  his 
activities  in  gaining  a  living. 

We  must  be  careful,  however,  to  see  that  we  do  not 
narrow  our  study  to  the  provision  of  the  physical 
necessities  of  existence.  It  is  true  that  a  man  can  live 
on  a  certain  minimum  of  food,  clothing,  and  shelter. 
If  his  food  be  sufficient  to  keep  body  and  soul  together 
and  his  clothing  adequate  to  protect  him  from  the 
extremes  of  climate,  he  can  live.  But  man  does  not 
live  by  bread  alone.  Much  more  goes  to  the  fulfillment 
of  the  highest  possibilities  of  life.  Variety  in  food, 
convenience  and  art  in  clothing,  space  and  beauty  in 
architecture  are  becoming  more  and  more  necessary. 
Literature,  art,  music  are  all  real  necessities  although 
the  physical  being  can  be  supported  without  them.  In 
short,  man  wants  to  do  more  than  exist;  he  wants  to 


THE   MEANING  OF  ECONOMICS  3 

live;  to  gain  the  fullest  possible  returns  from  the 
exertion  of  his  powers. 

The  study  of  economics  is  not  mercenary  or  ignoble. 
The  whole  of  the  graces  and  beauties  of  life  are 
dependent  upon  a  sound  basis  of  economic  life.  To 
put  it  crudely,  the  pursuit  of  wealth  for  its  own  sake 
may  be  unworthy  and  mean,  but  without  wealth  all 
the  better  sides  of  life  are  impossible. 

Economics  a  Social  Science  —  Consequently  eco- 
nomics is  related  to  all  other  social  sciences.  It  is 
related  to  history,  which  is  the  record  of  the  past 
activities  of  man;  it  is  related  to  psychology,  which 
is  the  study  of  his  mental  processes;  it  is  related  to 
geography,  which  is  the  study  of  the  earth  upon  which 
he  lives ;  it  is  related  to  ethics,  which  is  the  study  of 
his  morals ;  and  to  religion,  which  is  the  study  of  his 
hopes  and  aspirations. 

The  fact  of  these  relations,  however,  does  not 
prevent  us  from  studying  economics  as  a  separate 
science.  It  differs  in  some  important  essentials  from 
the  other  subjects.  It  differs  from  history  in  that  it  is 
as  much  concerned  with  the  future  as  with  the  present 
or  past,  and  yet  its  basis  is  in  history,  for  without 
history  we  cannot  interpret  the  present  or  attempt  to 
see  our  way  in  the  future.  Economics  utilizes  geog- 
raphy as  the  science  which  explains  the  phenomena 
of  earth  resources  with  which  man  as  an  economic 
animal  must  deal.  Psychology  is  essential  as  an 
instrument  whereby  we  can  understand  the  mental 
processes  which  lead  to  man's  actions.  And  ethics 
and  religion  provide  the  aims  towards  which  economic 
activity  should  lead. 


4  AN   INTRODUCTION   TO  ECONOMICS 

This  does  not  mean  that  the  study  of  all  these  sub- 
jects in  careful  detail  is  necessary  for  the  understanding 
of  the  main  principles  of  economics,  but  it  does  em- 
phasize the  fact  that  economics  is  a  branch,  and  not  the 
least  important  branch,  of  the  great  group  of  sciences 
which  are  generally  known  as  the  social  sciences. 

Economics  is  peculiarly  a  social  science,  in  that  it 
concerns  man,  not  as  an  individual,  but  as  a  society  or 
group.  The  vagaries  of  action  in  the  individual  are 
impossible  to  predict,  but  the  action  of  a  group  under 
given  circumstances  can  often  be  predicted  with  almost 
mathematical  accuracy.  This  fact  must  be  constantly 
borne  in  mind.  In  economics  we  are  not  dealing  with 
any  particular  Mr.  Smith  or  Mr.  Robinson,  but  with 
man  as  averaged  in  groups.  The  insurance  company 
with  a  hundred  thousand  policyholders  cannot  say 
which  particular  policyholder  will  die  in  any  given 
year.  But  it  can  predict  within  very  close  limits  how 
many  of  the  policyholders  will  die  in  that  year.  In 
fact,  if  it  were  not  able  to  do  so,  there  would  be  no  possi- 
bility of  the  existence  of  an  insurance  company. 

If  a  banking  institution  in  a  certain  city  should  fail, 
it  would  be  impossible  to  say  how  the  failure  would 
affect  the  individual  depositors  and  shareholders.  But 
it  would  be  a  much  easier  matter  to  predict  how  the 
failure  would  affect  the  commercial  community  in 
which  the  bank  was  situated.  The  individual  man  is 
affected  by  all  sorts  of  private  and  individual  con- 
siderations. But  these  cancel  one  another  in  the  large 
group,  and  only  those  effects  which  are  directly  the 
result  of  the  economic  cause  are  seen.  Hence  in  our 
study  we  can  afford  to  ignore  all  private  considerations. 


THE  MEANING  OF  ECONOMICS  5 

But  while  we  ignore  them,  we  must  not  be  blind  to 
their  existence.  We  must  constantly  realize  that  we 
are  dealing  with  averages.  This  is  a  commonplace  of 
science.  In  chemistry  we  study  the  individual  elements 
although  probably  most  of  thorn  are  seldom  found  in 
the  pure  state.  In  physics  we  study  simple  laws  of 
motion  before  we  consider  the  effects  of  modifying 
forces. 

The  Subject  Matter  of  Economics  —  We  may  now 
turn  to  the  question  of  the  nature  of  the  material 
which  forms  the  subject  matter  of  economics.  Without 
exhausting  the  material,  we  may  say  that,  funda- 
mentally, economics  examines  into  the  causes  which 
affect  the  production,  distribution,  and  consumption 
of  wealth ;  and  in  that  examination,  the  study  of  the 
organization  of  industry  and  trade,  the  mechanism  of 
exchange,  the  relations  between  employer  and  employed 
is  essential.  The  nature  of  the  control  exerted  upon 
economic  processes  by  individuals  and  by  governments 
falls  naturally  into  its  place  in  the  general  study. 

All  social  existence  necessitates  a  certain  amount  of 
organization  and  government,  and  the  proportioning 
of  the  expense  of  securing  this  organization  and  govern- 
ment also  forms  part  of  the  study  of  economics.  That 
is  to  say,  part  of  the  subject  consists  in  the  study  of  the 
extent  and  methods  of  taxation,  and  part  also  in  the 
extent  and  nature  of  governmental  expenditure. 

It  will  readily  be  seen,  therefore,  that  economics 
touches  very  closely  upon  the  allied  subjects  of  political 
science  and  history.  The  basis  of  the  study  must  be 
in  history,  however.  Nature  does  not  progress  by 
leaps  and  bounds,  but  by  slow  processes,  and  the 


6  AN  INTRODUCTION  TO  ECONOMICS 

development  of  a  civilization  is  no  exception  to  the 
rule.  Each  institution  is  more  a  growth  than  an  in- 
vention. We  can  trace  our  present  institutions  back 
to  the  past,  and  show  how  the  gradual  changes  have 
been  made  to  secure  the  remedies  for  the  faults  which 
have  appeared  with  varying  conditions.  No  institution 
is  ever  perfect ;  all  are  adaptations  of  older  ideas  to  new 
conditions.  And  so  we  cannot  understand  our  existing 
institutions  without  understanding  also  the  conditions 
which  gave  them  birth. 

We  are  studying  economic  conditions  and  institutions, 
however,  and  are  not  concerned  with  institutions  which 
have  no  economic  importance.  We  are  not  called  upon 
to  make  an  exhaustive  study  of  all  the  historic  in- 
fluences which  have  helped  to  mold  the  present  civiliza- 
tion. We  are  concerned  merely  with  that  portion  of 
history  which  may  be  called  economic  history.  In  other 
words,  we  must  study  those  historical  conditions  which 
have  directly  led  to  the  establishment  and  growth  of 
our  modern  economic  organization.  Again,  in  this 
connection,  we  must  remember  that  economic  history 
is  only  a  part  of  general  history.  In  the  same  way 
religious  history  is  a  part,  as  well  as  constitutional  and 
legal  history.  We  are  not  supposing  that  all  develop- 
ment is  due  to  economic  conditions,  but  we  do  suppose 
that  economic  conditions  have  had  a  very  important 
influence  upon  our  development,  and  that  they  will 
continue  to  do  so. 

Economic  Laws  — In  the  study  of  this  historical 
development,  the  economist  is  not  interested  merely  in 
facts.  What  he  aims  at  is  the  correlation  of  facts  so 
that  he  can  trace  the  causes  which  have  produced  the 


THE  MEANING  OF  ECONOMICS  7 

effects  he  wishes  to  study.  Just  so  the  scientist  is  not 
interested  in  the  phenomena  which  he  investigates 
purely  for  themselves,  but  for  the  purpose  of  explaining 
the  phenomena,  and  evolving  from  his  continued  studies 
the  laws  which  govern  the  actions  of  nature.  The 
scientist  seeks  to  discover  scientific  laws.  The  econo- 
mist seeks  to  discover  economic  laws. 

There  are  two  meanings  which  we  can  attach  to  the 
word  law.  We  may  speak  of  laws  as  a  legislator  uses  the 
term.  That  is,  we  may  consider  them  as  commands 
laid  down  by  those  in  authority  to  be  obeyed  by  the 
people.  A  scientific  or  natural  law  is  not  of  this  nature. 
The  scientist  does  not  say  that  all  bodies  shall  be 
mutually  attractive  but  that,  on  the  contrary,  all 
bodies,  as  a  matter  of  fact,  are  so.  In  other  words,  the 
legal  law  is  a  command  which  is  often  disobeyed  and 
penalties  are  imposed  on  the  disobedient.  The  natural 
law  is  never  disobeyed  and  consequently  there  are  no 
penalties  for  disobedience.  The  natural  law  states 
that,  given  certain  causes,  certain  results  must  ensue. 
It  is  this  latter  idea  of  law  which  is  used  in  regard  to 
the  term  economic  law.  An  economic  law  is  a  state- 
ment of  the  tendency  for  certain  economic  results  to 
follow  upon  certain  given  economic  causes  or  conditions. 
It  is  of  the  utmost  importance  to  remember  this  fact 
if  the  student  is  to  avoid  the  common  errors  in  the 
colloquial  use  of  the  term  economic  law. 

There  is  nothing  final  about  an  economic  law  any 
more  than  there  is  about  a  natural  law.  Whenever  a 
scientist  formulates  a  new  natural  law,  he  proceeds  to 
test  its  validity  by  creating  the  given  conditions  and 
then  watching  for  the  results.  As  long  as  his  "  law  " 


8  AN  INTRODUCTION  TO  ECONOMICS 

always  satisfactorily  explains  the  results,  it  is  con- 
sidered as  valid.  But  the  moment  a  case  arises  which 
is  not  covered  by  the  law,  then  the  law  must  be  re- 
stated so  that  it  covers  the  new  facts.  This  is  exactly 
the  case  with  the  economist.  His  laws  are  valid  only  so 
long  as  they  fit  the  facts.  If  they  do  not  fit  the  facts, 
then  they  must  either  be  stated  in  such  a  manner  that 
they  do  fit  them,  or  else  they  must  be  discarded  al- 
together. 

The  Deductive  Method  —  In  order  that  a  law  once 
formulated  shall  stand  the  tests  to  which  it  must  be 
put,  it  is  obviously  of  extreme  importance  that  the 
methods  by  which  it  is  formulated  should  be  sound. 
Essentially  there  are  two  processes  of  discovering  these 
laws.  They  may,  for  example,  be  formulated  on  the 
mathematical  method.  In  geometry,  for  instance,  we 
postulate  certain '  facts,  and  from  the  basis  of  these 
postulates,  we  develop,  by  a  process  of  pure  reasoning, 
certain  conclusions.  That  is,  we  use  the  method  of 
logic,  the  syllogism.  The  syllogism  consists  of  three 
parts.  First  there  is  a  general  statement;  this  is 
followed  by  a  subordinate  statement  related  to  the 
first.  From  these  two  statements  a  conclusion  is 
reached.  Let  us  take  an  example  of  such  reasoning  in 
order  better  to  understand  the  method. 

The  Syllogism  —  The  general  statement  is  usually 
termed  the  Major  Premise,  the  second  or  subordinate 
statement  is  the  Minor  Premise,  and  the  third  is  the 
Conclusion. 

Major  Premise.  True  colonization  is  impossible  unless 
permanent  residence  of  the  colonist  is 
possible. 


THE  MEANING  OF  ECONOMICS  9 

Minor  Premise.  Permanent  residence  of  British  colonists  in 
India  is  impossible  on  account  of  the 
climate. 

Conclusion.  British  occupation  of  India  cannot  be  true 

colonization. 

Now  the  only  way  in  which  we  can  test  the  truth  of 
this  conclusion  is  to  see  whether  it  fits  the  observed 
facts.  In  this  case  the  conclusion  is  sound,  for  it 
satisfies  all  the  facts.  But  sometimes  we  find  that  the 
conclusion  is  not  justified  by  the  facts.  For  example, 
take  the  following  argument. 

All  workmen  desire  the  highest  wages  they  can  get. 
All  workmen  are  free  to  move  whereyer  they  will. 
Therefore  a  rise  in  wages  in  one  part  cf  a  country  will 
attract  workmen  from  other  parts. 

In  this  case  the  facts  do  not  always  agree  with  the 
conclusion.  Either  something  is  wrong  with  our 
conclusion,  or  else  with  our  premises.  Though  we 
may  admit  the  general  truth  of  the  major  premise,  we 
cannot  altogether  admit  the  truth  of  the  minor.  There 
may  be  no  legal  objection  to  the  free  movement  of 
workmen  from  one  place  to  another,  but  nevertheless 
there  are  many  other  objections  which  tend  to  prevent 
such  movement.  A  workman  may  not  wish  to  leave 
his  present  home,  or  his  friends  ;  he  may  not  know  of  the 
rise  in  wages  in  the  other  place ;  there  may  be  conditions 
of  climate  or  situation  which  make  the  other  place  less 
attractive,  and  so  on.  Hence  our  conclusion  is  not 
justified  because  the  premises  are  not  complete. 

It  is  obvious,  therefore,  that  we  must  exercise  great 
care  in  examining  our  premises  before  we  draw  our 


10  AN  INTRODUCTION  TO  ECONOMICS 

conclusion.  And  when  we  have  so  examined  our 
premises,  then  we  must  apply  the  conclusion  to  the 
facts.  This  is  always  the  ultimate  test.  If  our  con- 
clusion, or  "  law  "  does  not  fit  the  facts,  then  it  is 
worthless,  no  matter  how  logically  it  may  be  drawn. 

The  Inductive  Method  —  This  mathematical  method 
of  reasoning  is  usually  called  the  deductive  method. 
But  it  is  not  the  only  way  in  which  we  can  formulate 
those  economic  laws  about  which  the  greater  part  of 
our  study  is  concerned.  If  we  note  that  in  past  ages  a 
certain  result  has  always  followed  upon  certain  causes, 
we  may  believe  that  in  the  future  there  is  every  reason 
for  supposing  that  that  result  will  continue  to  follow 
on  the  same  cause.  To  take  a  concrete  example, 
suppose  that,  on  examination,  we  find  that  every  time 
slave  labor  has  been  abolished  and  free  labor  sub- 
stituted, there  has  been  an  increase  in  efficiency  of  labor 
and  generally  a  more  abundant  and  better  production ; 
and  if  we  further  note  that  in  all  cases  where  there  has 
been  an  increase  in  individual  freedom  the  product  of 
the  labor  has  been  improved  in  quantity  and  in  quality, 
then  we  may  formulate  the  "  law  "  that  "  free  labor  is 
more  efficient  than  slave  labor."  Now  it  must  be 
noted  in  this  case  that  there  is  no  attempt  at  deductive 
reasoning.  We  have  merely  observed  certain  facts 
and  seen  that  in  every  case  the  same  result  has  followed 
upon  the  given  causes.  There  is  always  a  possibility, 
of  course,  that  in  some  future  time  we  may  find  that 
the  result  does  not  follow  as  before.  In  that  case,  we 
must  restate  the  law  so  that  it  meets  the  new  condition, 
or  else  we  must  try  to  see  whether  there  are  not  some 
other  circumstances  present  which  have  been  absent 


THE  MEANING  OF  ECONOMICS  11 

in  the  previous  cases  from  which  our  law  has  been 
formulated. 

This  may  seem  an  unscientific  method  of  reaching 
conclusions,  but  in  fact  it  is  one  of  the  commonest  of 
the  methods  used  in  natural  science.  The  familiar 
story  of  the  discovery  of  the  law  of  gravitation  by 
Newton  is  an  instance.  Newton  noticed  that  without 
support  the  apple  was  bound  to  fall  from  the  tree, 
and  that  similarly  any  other  body  suspended  above  the 
surface  of  the  earth  was  bound  to  fall  as  soon  as  its 
support  was  removed.  From  these  elementary  facts 
and  from  further  close  observation,  Newton  was  able 
to  formulate  the  law  that  all  bodies  tend  to  attract 
one  another  with  a  force  varying  inversely  as  the 
square  of  the  distance,  and  directly  as  the  mass  of  the 
bodies.  Test  after  test  produced  the  same  result  and 
hence  we  have  accepted  the  law  as  true. 

The  same  method  must  be  used  in  the  discovery  of 
economic  laws  and  the  same  tests  applied.  The  con- 
stant application  of  the  law  to  existing  facts  tends  to 
make  the  statement  of  the  law  more  and  more  satis- 
factory. This  process  of  discovering  economic  or 
other  laws  is  called  the  inductive  method. 

Value  of  Economic  Laws  —  A  natural  question  to 
ask  is,  what  is  the  value  of  these  economic  laws  ? 
Without  systematization  there  can  be  no  real  knowl- 
edge. In  fact  science  is  distinguished  from  ordinary 
knowledge  merely  because  it  is  systematized  or  or- 
ganized. The  value  of  the  laws  discovered  in  physical 
science  is  that  not  only  can  the  present  be  explained, 
but  the  future  can  be  predicted.  If  the  economic 
laws  are  to  be  of  any  real  value,  they  must  enable 


12  AN  INTRODUCTION  TO  ECONOMICS 

us  to  avoid  errors  in  development  by  predicting  the 
future,  at  any  rate  to  the  extent  of  warning  us  of 
dangers  which  from  all  past  experience  seem  bound 
to  occur  if  a  certain  course  is  persisted  in.  In  other 
words,  the  discovery  and  statement  of  economic  laws 
helps  to  prevent  the  recurrence  of  past  mistakes 
and  to  secure  a  sound  and  steady  development  in  the 
future. 

From  this,  there  arises  the  question  of  the  scope  of 
the  economist's  activities.  'Is  he  merely  concerned 
with  the  analysis  of  past  and  existing  economic  con- 
ditions and  reducing  them  to  order,  or  should  he 
also  attempt  to  show  how  the  existing  system  can  be 
improved  ? 

The  Scope  of  Economics  —  Primarily  we  may  say 
that  the  economist  is  purely  an  analyst.  We  do  not 
expect  the  professor  of  physics  to  invent  new  niachines. 
We  leave  that  to  the  inventor  or  engineer  who  applies 
in  practice  what  the  professor  of  physics  teaches  and 
discovers  in  theory.  Similarly  we  may  say  that  the 
statesman  applies  in  practice  the  theories  developed 
by  the  economist.  But  the  economist  is  a  human  being 
with  a  human  being's  inability  to  limit  himself  absolutely 
to  one  thing.  He  sees  perhaps  more  clearly  than  any 
other  the  faults  of  the  existing  system  of  organization, 
for  no  one  will  attempt  to  deny  that  it  has  great  faults. 
Moreover,  he  sees  the  evil  effects  of  remedies  suggested 
by  people  who  have  no  clear  knowledge  of  the  causes  of 
the  evils,  or  of  the  remedies  which  have  been  attempted 
in  the  past. 

The  economist  finds  himself  intrenching  upon  the 
scope  of  the  student  of  ethics  and  often  of  that  of  the 


THE  MEANING  OF  ECONOMICS  13 

preacher,  but  he  limits  himself  to  a  definite  line  of 
action.  He  is  concerned  primarily  with  the  develop- 
ment of  economic  organization,  but  wherever  that 
organization  is  affected  by  ethical  and  religious  ideas, 
then  he  must  consider  the  effects  of  those  ideas. 

Summary  —  We  may  now  sum  up  the  conclusions 
we  have  arrived  at  in  this  chapter.  Economics  is  the 
science  which  deals  with  man  in  regard  to  his  means  of 
gaining  a  living.  It  is  concerned,  therefore,  with  such 
subjects  as  the  production,  exchange,  and  distribution 
of  wealth ;  the  organized  relations  between  employer 
and  employed ;  the  economic  actions  of  government  in 
securing  a  revenue  and  then  in  expending  that  revenue ; 
and,  in  short,  with  all  matters  that  affect  the  physical 
well-being  of  mankind. 

!  Economics  deals  with  societies  of  men  rather  than 
with  individuals,  but  recognizes  that  societies  consist 
of  groups  of  individuals.  And  so,  while  no  particular 
Mr.  Smith  or  Mr.  Robinson  can  be  considered,  the 
welfare  of  all  the  Smiths  and  Robinsons  is  the  ultimate 
aim  of  all  social  study. 

The  economist  analyzes  the  past  and  present  eco- 
nomic conditions  and  organizations  with  a  view  to 
explaining  them  and  to  pointing  out  the  reasons  for 
their  failure,  or  at  least  for  the  constant  change  which 
these  institutions  and  organizations  have  undergone. 

And  finally,  the  economist,  realizing  that  the  present 
system  is  very  far  from  being  the  most  satisfactory 
possible,  endeavors  to  give  sound  criticism  to  all 
schemes  of  proposed  reform  and  also  to  formulate 
schemes  himself,  basing  those  schemes  or  suggestions 
on  his  scientific  knowledge  of  the  present. 


14  AN  INTRODUCTION  TO  ECONOMICS 

We  have  therefore  undertaken  a  study  of  a  science 
which,  while  it  is  not  to  be  regarded  at  present  as  being 
complete,  is  one  of  immense  importance  to  the  world. 
Without  it,  all  efforts  at  improving  the  condition  of 
mankind  will  be  of  little  avail. 


CHAPTER  II 

THE  THEORY   OF  ECONOMIC  DEVELOPMENT 

Economic  History  —  A  good  deal  was  said  in  the 
last  chapter  regarding  the  importance  of  history  in  the 
study  of  economics.  It  is  impossible,  even  if  it  were 
desirable,  to  give  a  complete  account  of  economic  de- 
velopment in  the  present  study.  Nevertheless  it  is 
possible  to  indicate  the  general  theory  of  economic 
development  so  that  the  reader  may  have  the  necessary 
basis  for  the  future  study.  History  is  not  a  mere  hap- 
hazard study  of  unrelated  facts.  Facts  in  themselves 
are  not  important ;  it  is  in  their  significance  that  their 
importance  lies.  The  whole  value  of  the  study  of  the 
facts  and  events  of  history  lies  in  the  possibility  of 
determining  the  nature  of  historical  progress.  The 
antiquary  is  interested  in  the  life  of  the  past  apart 
from  all  consideration  of  the  influence  of  the  past  upon 
the  present,  but  the  antiquary  and  his  studies  are  of 
no  importance  to  the  economist.  What  we  want  to 
find  out  is  whether  there  are  any  laws  of  development ; 
that  is,  whether  economic  growth  is  the  result  of  acci- 
dent or  of  a  definite  method  of  development. 

Nothing  happens  in  nature  without  a  cause.     The 

effects  of  certain  causes  become  themselves  the  cause 

of  future  events  and  if  we  could  discover  it,  we  should 

find  that  there  is  a  definite  chain  of  causes  and  effects 

15 


16  AN  INTRODUCTION  TO  ECONOMICS 

going  right  back  to  primitive  history.  The  tracing 
of  that  chain  of  events  belongs  to  the  study  of  history, 
but  the  results  of  the  historian's  work  must  be  used 
by  the  economist. 

We  can  realize  that  there  is  a  definite  line  of  progress 
leading  from  a  simple  organization  to  a  more  complex 
until  we  arrive  at  the  extreme  complexity  of  the  modern 
economic  structure.  What  that  line  is  we  must  now 
proceed  to  indicate. 

The  Four  Stages  of  Development  —  In  the  main  we 
may  distinguish  four  chief  periods  in  the  development 
of  the  human  race.  The  first  is  the  period  of  depend- 
ent life,  the  second  is  that  of  pastoral  life,  and  the 
third  the  agricultural  period.  The  final  stage  is  that 
of  industrial  life. 

The  Dependent  Period  —  In  primitive  times  man  was 
dependent  upon  what  he  could  reap  from  nature  without 
contributing  himself.  He  obtained  his  food  either  from 
the  roots  and  fruits  which  grew  wild  or  from  hunt- 
ing wild  animals.  The  results  of  the  chase  brought 
him  his  food  and  his  clothing,  as  well  as,  in  those 
climates  where  shelter  was  necessary,  his  shelter.  He 
ate  the  meat  of  the  animals  he  killed  and  used  the 
skins  either  to  clothe  himself  or  to  provide  a  tent  in 
which  to  sleep.  He  contributed  nothing  to  nature. 
He  took  what  existed,  and  left  the  provision  of  his 
future  needs  to  the  powers  of  unaided  nature.  His 
life  was,  therefore,  entirely  dependent  upon  the  simple, 
natural  productions,  and  existence  was  necessarily 
hand  to  mouth.  In  other  words,  he  lived  the  life  of 
the  wild  animal,  producing  nothing  himself.  If  nature 
were  bountiful,  he  lived  well.  If  nature  were  niggardly, 


THE  THEORY  OF  ECONOMIC  DEVELOPMENT  17 

then  his  existence  became  a  fight  against  starvation. 
Nature  unaided  tends  in  most  climates  to  be  niggardly, 
and  hence  the  whole  of  life  was  taken  up  with  the 
struggle  for  existence. 

The  Pastoral  Period  —  The  first  great  development 
took  place  when  man  learned  to  tame  the  hitherto  wild 
animals.  He  ceased  to  be  entirely  dependent  upon  the 
chase.  His  food  and  clothing  became  more  certain 
and,  what  was  of  infinite  importance,  he  was  able  to 
associate  in  larger  groups  than  formerly.  Life  ceased 
to  be  the  absolute  hand-to-mouth  existence  that  it 
was  in  the  more  primitive  times.  The  comparative 
leisure  enabled  him  to  add  to  his  knowledge  and  to 
develop  his  mind.  The  pastoral  life  in  itself  tended  to 
encourage  the  contemplative  form  of  life,  and  hence 
paved  the  way  for  a  higher  type  of  mind  as  well  as  for 
a  better  nourished  body.  We  do  not  need  to  depend 
entirely  upon  conjecture  to  know  that  these  two  stages 
of  development  actually  existed.  We  know  that  the 
Indians  of  America  lived  very  largely  in  the  dependent 
stage.  They  lived  upon  the  fruits  of  the  chase,  clothing 
themselves  and  providing  their  tents  from  the  skins 
of  the  animals  they  killed.  Many  existing  races  still 
live  in  the  pastoral  stage.  Perhaps  as  good  a  descrip- 
tion of  the  life  as  can  be  given  is  contained  in  those 
chapters  of  the  book  of  Genesis  which  deal  with  the 
life  of  Abraham  and  Lot.  The  constant  traveling 
from  place  to  place  as  pasture  after  pasture  is  ex- 
hausted ;  the  gradual  growth  of  the  flocks  of  each 
until  eventually  there  is  not  room  for  both  in  the  same 
district;  and  the  consequent  separation,  are  typical 
of  the  life. 


18  AN  INTRODUCTION  TO  ECONOMICS 

It  is  well  to  notice  in  this  connection  that  in  the 
more  primitive  method  of  living  the  group  is  smaller. 
The  hunting  life  does  not  support  a  large  group.  Game 
moves  away  where  the  danger  is  too  great  and  hence 
the  group  must  split  up  in  pursuit  of  new  hunting 
grounds.  The  pasture  is  exhausted  rapidly  with  large 
flocks,  but  nevertheless  the  pastoral  group  is  larger 
than  the  hunting  group. 

The  Agricultural  Stage  —  When  the  next  stage  of 
development  arrives,  there  is  opportunity  for  the 
growth  of  a  much  larger  group.  The  pastoral  group 
is  less  absolutely  dependent  upon  the  gifts  of  nature 
than  the  hunting  group  but  the  agricultural  stage 
means  a  still  greater  addition  to  the  human  effort  with 
a  consequent  lessening  of  the  dependence  upon  un- 
aided nature.  The  farmer  tills  the  soil  and  so  makes 
greater  use  of  the  powers  of  nature.  He  is  not  com- 
pelled to  move  constantly  from  place  to  place  in  order 
to  supply  the  needs  of  his  existence.  More  people  can 
be  cared  for  on  a  given  area  than  under  either  of  the 
preceding  stages.  Hence  we  find  that  the  groups  are 
larger  and  the  consequent  closer  association  of  mind 
with  mind  produces  a  still  higher  type  of  intelligence 
than  has  been  possible  before.  It  is  true  that  the 
earliest  forms  of  agriculture  were  extremely  crude. 
Soil  was  very  rapidly  exhausted  by  continuous  cropping 
with  the  same  crops,  and  hence  there  were  movements 
to  new,  virgin  soil.  But  the  gradual  advance  of  agri- 
cultural knowledge  made  it  possible  to  prolong  the 
productive  life  of  the  soil  and  so  the  necessity  to  move 
to  new  lands  became  less  and  less  frequent. 

The  Industrial   Stage  —  This   gradual   development 


THE  THEORY  OF  ECONOMIC  DEVELOPMENT   19 

of  economic  organization  led  to  the  growth  of  that 
principle  which  has  been  of  the  greatest  service  in 
rendering  possible  the  complex  life  of  the  present  day. 
The  principle  is  that  of  the  division  of  labor.  Even  in 
primitive  times  a  certain  amount  of  specialization  of 
labor  was  possible.  We  read  in  accounts  of  primitive 
tribes,  such  as  those  described  in  Longfellow's  Hia- 
watha, that  even  in  groups  that  supported  themselves 
entirely  by  hunting  there  were  members  of  the  group 
especially  skilled  in  the  making  of  instruments  of  the 
chase  —  makers  of  arrowheads,  for  instance.  Ob- 
viously the  man  who  devoted  most  of  his  time  to  the 
making  of  arrows  could  not  spend  much  time  in  actual 
hunting,  and  so  he  had  to  exchange  the  products  of  his 
industry  for  those  of  the  hunters.  And  the  more 
skillful  became  the  arrow  maker,  the  more  dependent 
upon  him  were  the  actual  hunters  themselves  whose 
time  was  taken  up  in  the  use  of  the  weapons  provided 
by  the  arrow  maker. 

Definition  of  Economic  Unit  —  This  becomes  more 
and  more  true  as  the  specialization  advances.  When 
the  maker  of  weapons  is  supplemented  by  the  maker 
of  agricultural  implements,  and  he  in  turn  by  the  tent 
maker  and  later  the  builder,  we  notice  a  gradual  in- 
crease in  the  interdependence  of  the  members  of  a 
community.  When  we  find  one  group  which  provides 
for  itself  all  the  necessities  of  life,  without  being  de- 
pendent to  any  extent  upon  the  produce  of  any  other 
group,  we  call  that  group  an  economic  unit.  With 
each  improvement  in  organization  there  is  an  extension 
of  the  economic  unit.  The  more  the  individuals  who 
compose  a  unit  specialize  in  some  form  of  production 


20  AN  INTRODUCTION  TO  ECONOMICS 

or  other,  the  more  are  the  members  of  the  group  de- 
pendent upon  each  other.  And  also,  the  more  members 
can  the  group  sustain. 

Characteristics  of  Development  —  The  natural  de- 
velopment resultant  upon  this  increase  in  specialization 
or  division  of  labor  is  the  rise  of  the  latest  stage  in 
existence,  the  industrial  stage.  In  this  stage  of  de- 
velopment we  see  a  steadily  increasing  interdependence 
of  the  members  of  a  group  and  a  steadily  increasing 
number  of  members  in  the  group.  We  are  at  present 
living  in  the  industrial  stage  of  civilization  which  seems 
to  be  the  ultimate  form.  Specialization  is  carried  to 
a  very  high  degree.  Instead  of  having  a  very  few  vari- 
eties of  employment,  the  possible  varieties  are  infinite 
and  are  increasing  day  by  day.  Industries  which  in 
the  time  of  our  fathers  were  units  are  now  subdivided 
to  a  degree  undreamed  of  in  the  past  generation.  A 
shipbuilder,  for  instance,  no  longer  designs  the  boat, 
cuts  the  lumber,  shapes  and  erects  it,  and  finally  paints 
the  hull.  The  design  is  cared  for  by  a  naval  architect. 
It  is  drawn  by  a  draftsman.  The  drawing  is  printed 
in  a  blue-print  office ;  the  blue  prints  are  used  by  the 
loftsmen  to  make  the  templates;  the  templates  are 
used  by  the  shipwrights  to  make  the  shapes  and  so 
forth,  until  the  list  of  trades  concerned  in  the  produc- 
tion of  ships  looks  like  a  catalogue  of  all  possible  in- 
dustries. This  instance  could  be  multiplied  to  an 
unlimited  extent.  In  1776,  Adam  Smith  was  amazed 
at  the  number  of  operations  which  were  necessary  in 
the  manufacture  of  a  common  pin.  He  enumerated 
eighteen.  It  is  safe  to  say  that  there  are  a  hundred 
now. 


THE  THEORY  OF  ECONOMIC  DEVELOPMENT  21 

Relations  between  the  Stages  of  Development  —  It 
must  not  be  thought  that  these  stages  of  development 
are  definitely  distinct  from  one  another.  At  the  present 
time  we  make  use  of  all  three  methods  of  securing  our 
necessities.  The  fish  we  eat  are  procured  by  methods 
comparable  to  those  of  the  hunting  stage  of  existence, 
although  it  is  true  that  our  means  of  catching  fish  are 
better  than  those  of  primitive  times;  and  it  is  also 
true  that  we  do  what  was  not  thought  of  in  purely 
dependent  times  —  we  try  to  restore  what  we  take 
from  the  sea  by  cultivating  the  spawn  of  fish,  as  in  the 
salmon  trade,  for  instance.  Our  meat  is  the  product 
of  the  pastoral  life,  although  the  cowboy  of  the  western 
plains  is  hardly  the  same  type  as  the  Arabian  shepherd. 
And  our  crops  are  the  product  of  the  agricultural  stage. 
Each  succeeding  stage  is  rather  superimposed  on  the 
previous  than  a  substitute  for  it. 

Variations  in  Rate  of  Development  —  One  distinc- 
tion is  important,  however.  Progress  was  very  slow 
in  primitive  times.  It  is  very  rapid  now.  The  change 
from  the  dependent  to  the  pastoral  life  probably  oc- 
cupied many  centuries.  The  development  of  primi- 
tive agriculture  was  probably  much  quicker  in  following, 
and  the  germs  of  the  industrial  stage  were  to  be  seen 
before  the  agricultural  stage  had  made  much  headway. 

In  the  industrial  stage  the  development  has  been 
increasingly  rapid.  There  is  more  difference  between 
the  workman's  occupation  in  the  twentieth  century 
and  in  the  early  nineteenth,  than  between  the  life  of 
the  eighteenth-century  laborer  and  that  of  the  twelfth- 
century  workman.  This  is  largely  because  the  de- 
velopment is  ceasing  to  be  unconscious  as  it  was  in  the 


22  AN  INTRODUCTION  TO  ECONOMICS 

earlier  times  and  is  becoming  increasingly  conscious. 
That  is  to  say,  in  early  times  changes  were  very  slight 
and  were  introduced  very  gradually,  so  gradually,  in 
fact,  that  they  were  not  noticed.  It  is  probable,  in- 
deed, that  they  would  not  have  been  introduced  at 
all  had  they  been  noticeable.  Primitive  man  was 
resentful  of  change  and  even  at  the  present  day  we 
notice  a  much  stronger  tendency  to  conservatism  in 
backward  peoples  than  in  more  enlightened  races. 
When  changes  were  actually  noticeable  as  definite 
innovations,  they  were  invariably  resisted  and  only 
succeeded  by  their  inherent  advantages  gradually 
overcoming  the  reluctance  of  the  people  to  change. 
The  higher  the  civilization,  the  less  reluctance  is  there 
to  a  change  which  promises  an  improvement.  At  the 
present  time  in  all  advanced  countries,  changes  in 
organization  and  in  methods  of  production  have  ceased 
to  be  accidental  and  are  consciously  adopted  and  even 
sought. 

Modern  Civilization  Dynamic  —  The  older  civiliza- 
tions conceived  themselves  as  static.  In  other  words 
they  believed  implicitly  that  they  were  the  final  word. 
We  realize  now  that  our  civilization  is  dynamic.  That 
is,  we  know  that  we  cannot  stand  still.  All  change  is 
not  improvement,  but  there  cannot  be  improvement 
without  change.  We  are  not  satisfied  with  our  lives. 
We  wish  constantly  to  improve  them  and  are  con- 
stantly seeking  the  best  means  by  which  an  improve- 
ment can  be  made. 

This  is  seen  in  the  amazing  number  of  inventions 
which  are  daily  patented  in  the  principal  countries  of 
the  world  and  particularly  in  America.  No  sooner 


THE  THEORY  OF  ECONOMIC  DEVELOPMENT  23 

is  a  machine  invented  than  attempts  are  made  to 
improve  it.  All  those  industries  which  have  been 
formerly  carried  out  by  individual  skill  are  being  as 
far  as  possible  reduced  to  a  routine  of  motion,  with  a 
view  to  the  supplanting  of  human  effort  by  machinery. 
Take  the  art  of  printing,  for  example.  Originally  the 
type  blocks  were  cut  by  hand.  Now  they  are  cast 
from  molds.  Originally  they  were  set  up  by  hand. 
Now  they  are  set  up  by  means  of  the  linotype  or  the 
monotype  machine.  We  use  electrotypes  where  for- 
merly we  used  hand  engravings.  We  fold  the  paper 
and  bind  it  by  machinery  instead  of  by  hand. 

Sufficient  has  now  been  said  to  illustrate  the  method 
of  development.  We  must  now  ask  whither  is  the 
development  leading,  or  what  is  the  object  at  which 
all  this  progress  aims  ? 

Growth  of  Civilization  Accompanied  by  Increase  in 
Needs  of  Man  —  The  advance  of  civilization  is  an  ad- 
vance in  the  needs  of  man.  The  more  highly  civilized 
he  is,  the  greater  is  the  number  of  his  wants.  Primitive 
man  had  few  requirements  and  had  a  great  struggle  to 
satisfy  these.  Modern  man  has  a  bewildering  number 
of  wants  and  the  possibility  of  satisfying  these  wants 
is  much  greater  than  the  possibility  of  satisfying  the 
few  necessities  of  the  savage. 

Physical  and  Conventional  Necessities  —  The  neces- 
sities of  the  savage  are  physical  necessities.  Without 
them  he  dies.  The  man  of  to-day  has  many  wants 
which  he  considers  as  necessities,  but  which  are  not 
essential  to  existence.  Life  and  existence  were  to  the 
savage  synonymous  terms.  They  are  not,  so  now.  We 
realize  more  and  more  fully  that  man  does  not  live  by 


24  AN  INTRODUCTION  TO  ECONOMICS 

bread  alone.  There  are  "  longings,  yearnings,  striv- 
ings "  which  must  be  satisfied.  After  all,  man  is  a 
social  animal.  He  is  interested  not  only  in  himself 
but  in  his  neighbors  and  in  his  surroundings.  Mental 
and  social  development  can  only  be  secured  by  a  certain 
amount  of  leisure,  a  leisure  which  is  impossible  when  all 
efforts  must  be  devoted  to  wringing  from  a  niggardly 
nature  the  bare  means  of  subsistence.  Hence  any- 
thing which  tends  to  subdue  nature,  to  gain  a  greater 
product  with  a  smaller  expenditure  of  effort,  tends  to 
increase  the  amount  of  leisure  which  can  be  devoted 
to  the  production  of  those  things  which  contribute  to 
mental,  social,  and  emotional  development. 

The  love  of  knowledge  must  be  fostered,  not  for  the 
sake  of  knowledge  itself,  but  because  each  increase  in 
knowledge  gives  a  greater  command  over  nature  and 
a  consequent  increase  in  the  satisfaction  that  man  ob- 
tains from  life.  In  a  struggle  for  existence  there  is  no 
place  for  beauty ;  everything  must  be  sacrificed  to  the 
production  of  necessities.  But  in  a  full  life,  beauty 
and  art  must  have  their  place.  A  house  must  no 
longer  be  a  mere  shelter,  but  a  place  with  a  beauty  of 
its  own,  a  delight  to  the  eye  as  well  as  a  protection 
from  the  elements.  Music  and  literature  are  neces- 
sities when  the  demands  of  the  purely  physical  being 
have  been  satisfied.  Life  consists  more  largely  in  the 
exchange  of  thoughts,  the  influence  of  mind  upon  mind, 
than  we  are  sometimes  inclined  to  believe.  There 
must  be  free  provision  for  the  communion  of  man  with 
man.  In  short,  our  "  progress  "  is  the  growth  of  success 
in  developing  the  physical  and  mental  man  to  the  fullest 
possible  extent. 


THE  THEORY  OF  ECONOMIC  DEVELOPMENT  25 

The  Economic  Problem  —  The  problem  which  con- 
fronts man,  then,  is  this :  Given  a  world  whose  re- 
sources are  infinite  but  not  all  discovered,  how  to  make 
use  of  the  known  resources  and  discover  the  unknown, 
so  that  each  may  satisfy  his  desires  to  the  fullest  extent 
without  infringing  upon  those  of  his  neighbors,  and 
without  waste. 

To  say  that  this  problem  is  solved  is  to  say  that  per- 
fection has  been  achieved  and  the  millennium  is  at 
hand.  What  we  have  to  do  in  our  succeeding  study 
is  to  examine  how  far  we  have  succeeded,  and,  in  so 
far  as  we  have  failed,  to  see  why  we  have  failed  and  how 
the  failure  may  be  remedied. 


CHAPTER  III 

THE   COMPETITIVE   SYSTEM 

In  the  last  chapter  we  stated  the  problem  which  the 
world  has  to  solve  —  the  provision  of  the  necessities 
and  conveniences  of  life  in  as  full  and  free  a  manner  as 
possible  to  all  its  inhabitants,  and  without  waste. 
To  say  that  this  problem  is  absolutely  solved  is,  of 
course,  untrue.  But  nevertheless  the  necessities  and 
conveniences  are  actually  produced,  perhaps  not  so 
economically  or  so  fully  as  is  possible,  and  certainly 
not  without  very  great  inecaialities  in  distribution. 

The  existing  system  of  production  and  distribution 
is  extremely  complex.  Indeed  it  would  seem  at  first 
glance  that  there  is  no  system  at  all,  but  merely  a  more 
or  less  haphazard  production  which  results  in  a  certain 
degree  of  efficiency.  As  a  matter  of  fact  the  methods 
of  production  and  distribution  at  the  present  time  do 
not  represent  a  conscious  organization  of  the  means  of 
production.  They  represent  rather  a  gradual  growth 
and  development  from  past  times,  helped  here  and  there 
by  conscious  attempts  at  remedying  the  structure  of 
the  system  as  it  broke  down  from  time  to  time. 

Still  there  seem  to  be  certain  principles  which  have 
governed  what  arrangement  there  was  in  the  different 
periods  of  growth,  and  in  the  present  chapter  we  shall 
try  to  see  if  there  are  any  which  can  be  said  to  control 
our  present  system. 


THE  COMPETITIVE  SYSTEM  27 

Economic  Freedom  —  The  keynote  to  modern  eco- 
nomic life  is  found  in  the  idea  of  economic  freedom. 
The  phrase  must  be  carefully  explained,  however, 
for  the  idea  involved  is  a  direct  revolution  from  that 
which  governed  our  organization  a  century  ago.  In 
the  older  society  which  preceded  ours  it  was  believed 
that  each  individual  had  his  place.  It  was  the  duty  of 
the  group  to  care  for  the  individual  and  the  individual 
was  responsible  to  the  group.  This  idea  may  be 
illustrated  by  the  gild  system,  about  which  more  will 
be  said  later.  The  trade  gild  regulated  the  work 
which  each  member  was  to  perform  and  the  remuner- 
ation he  was  to  receive.  The  style  and  quality  of  the 
work  was  controlled  to  a  very  large  extent  and  the 
amount  allotted  to  each  member  was  arranged  so  that 
the  work  should  be  divided  as  evenly  as  possible.  In 
case  of  the  death  of  a  breadwinner  of  a  family,  the  gild 
looked  after  the  widow  and  provided  for  the  care  of  the 
children  until  they  were  old  enough  to  enter  the  gild 
and  earn  their  own  living. 

When  the  gild  system  decayed  and  finally  broke 
down,  the  idea  of  a  regulated  industry  did  not  dis- 
appear, but  rather  was  emphasized  by  governmental 
action.  Government  controlled  all  industry  by  stipu- 
lating, for  instance,  what  industries  should  be  carried 
on  and  how  they  should  be  conducted.  Industries 
regarded  as  of  national  importance  were  encouraged 
by  the  offer  of  bounties  on  the  production  of  those 
industries  or  by  prohibiting  the  import  of  products  of 
competing  industries  in  other  countries.  Inspectors 
were  appointed  to  examine  the  products  of  the  indus- 
tries to  see  that  they  were  up  to  standard.  Inspectors 


28  AN  INTRODUCTION  TO  ECONOMICS 

in  the  wool  trade,  for  example,  enforced  the  govern- 
mental prohibition  of  mixtures  in  wools.  The  cloth 
must  be  of  one  grade  of  wool  alone.  It  must  be  of  a 
certain  width  and  the  bolt  a  certain  length.  The  very 
dyes  must  be  of  standard  quality  and  color. 

Regulation  of  Industry  —  Industries  regarded  as  un- 
suitable for  the  country  were  prohibited.  In  a  word, 
regulation  was  the  main  idea  in  industry.  There  was 
not  an  occupation  which  in  some  way  or  other  was  not 
subject  to  interference  by  the  government. 

When  industry  was  revolutionized  by  the  great 
inventions  of  the  latter  part  of  the  eighteenth  and  the 
beginning  of  the  nineteenth  centuries,  manufacturers 
became  more  and  more  resentful  of  the  control  exer- 
cised by  government.  They  demanded  the  right  to 
make  what  products  they  chose  and  in  the  way  they 
chose.  They  asked  that  workmen  should  be  allowed 
to  change  their  occupation  as  frequently  as  they  wished 
and  to  move  from  place  to  place  at  will.  They  did  not 
ask  for  bounties  to  produce  their  wares.  They  believed 
that  they  had  sufficient  incentive  to  production  in  the 
profits  to  be  derived  from  the  manufacture  and  sale  of 
the  goods. 

Production  for  Profit  Most  Satisfactory  System - 
In  short  they  believed  that  the  individual  understood 
his  own  business  a  great  deal  better  than  any  possible 
government,  and  a  theory  was  developed  to  justify 
their  ideas.  It  is  this  theory  which  we  must  now 
examine. 

At  its  basis  is  the  belief  that  the  fundamental 
incentive  to  all  industry  is  the  acquisition  of  property. 
It  was  thought  that  a  man  would  not  work  unless  he 


THE  COMPETITIVE  SYSTEM  29 

were  to  receive  for  his  own  use  the  fruits  of  his  industry. 
The  greater  wealth  to  be  achieved  in  an  industry,  the 
more  assiduously,  would  the  workers  in  that  industry 
labor.  Conversely,  if  there  were  no  profit  to  be  reaped, 
the  industry  would  languish  and  finally  disappear. 
The  two  propositions  were  sufficiently  well  illustrated 
to  give  an  apparent  justification  to  the  idea.  In  the 
manufacturing  business,  notably  the  textile  industries, 
great  profits  were  possible.  These  industries  developed 
rapidly  from  being  carried  on  in  private  homes  as  a 
part-time  occupation,  with  agriculture  as  a  mainstay, 
to  the  manufacture  in  huge  factories,  with  agriculture 
as  a  separate  industry.  The  converse  was  illustrated, 
for  example,  in  the  Irish  rack-renting  system.  In  this 
system  the  farm  lands  were  rented  by  a  species  of 
auction.  The  landowner  offered  his  land  to  the  farmer 
who  agreed  to  pay  the  highest  rent.  In  actual  opera- 
tion rents  were  offered  infinitely  in  excess  of  the  total 
possible  production  of  the  land.  Naturally  the  farmer 
when  he  obtained  the  land  was  not  able  to  gain  sufficient 
to  pay  the  rent,  and  consequently  he  immediately 
began  to  fall  into  arrears  with  his  payments.  The 
arrears  mounted  with  each  month  of  his  occupation  and 
hence  no  increase  in  the  harvest  was  sufficient  to  do 
more  than  wipe  out  a  portion  of  the  arrears  of  rent. 
If  the  farmer  tried  newer  methods,  or  spent  money  on 
manures  or  on  additional  labor,  he  reaped  no  reward, 
for  the  increase  in  the  product  went  directly  to  the 
landlord.  There  was  no  stimulus  to  increased  pro- 
duction, therefore,  and  with  the  knowledge  that  he 
could  never  secure  more  for  himself  than  a  bare  sub- 
sistence, the  farmer  sought  no  more  than  that.  His 


30      AN  INTRODUCTION  TO  ECONOMICS 

cultivation  was  slight  and  he  made  no  attempts  at 
improvement.  The  Irish  farming  became  perhaps  the 
worst  in  Europe,  simply  because  of  the  withdrawal  of 
the  property  stimulus. 

The  contention  that  this  property  stimulus  was 
essential  would  seem  to  be  proved,  but  at  present  we 
are  not  concerned  with  a  more  careful  examination. 
Later  on  we  shall  see  that  there  are  other  considerations 
to  be  taken  into  account.  For  the  present  we  shall 
admit  the  contention  for  the  sake  of  the  argument. 

The  next  point  to  be  considered  is  the  effect  of  this 
indiscriminate  production  on  the  general  welfare  of  the 
community.  Would  the  whole  of  the  needs  of  the 
community  be  satisfied  if  each  individual  were  left 
to  himself  to  produce  what  he  wished,  how  and  where 
he  liked?  Would  there  be  greater  production  in  va- 
riety and  extent  if  governmental  control  were  re- 
moved? These  were  considerations  which  had  to  be 
dealt  with. 

Basis  of  Argument  hi  Favor  of  Production  for  Profit  — 
Now  we  are  not  dealing  with  a  primitive  state,  but  with 
an  economic  system  which  had  reached  a  high  degree  of 
specialization.  Each  man  produced  only  a  small  part 
of  his  own  total  needs  and  relied  for  the  satisfaction  of 
his  wants  by  exchanging  his  own  surplus  product  for 
the  surplus  of  others.  Naturally  each  individual 
wanted  to  get  as  much  as  possible  for  his  surplus,  and 
his  gain  therefore  depended  upon  the  demand  which 
existed  for  the  particular  product  which  he  had  to 
exchange.  If,  for  instance,  a  man  was  engaged  in 
producing  knitting  needles,  he  could  only  exchange 
those  needles  to  people  who  required  them.  If  very 


THE   COMPETITIVE  SYSTEM  31 

few  people  wanted  knitting  needles,  then  he  would 
probably  be  left  with  a  supply  on  his  hands  and  he 
would  find  little  profit  in  the  undertaking.  If  he  were 
producing  wheat,  on  the  other  hand,  there  was  bound 
to  be  a  great  number  of  people  who  wished  to  ex- 
change their  products  for  the  result  of  his  harvesting. 
Hence  he  would  be  able  to  exchange  the  great  bulk  of 
his  surplus  comparatively  easily. 

Now  the  natural  result  of  this  method  of  production 
would  be  that  each  individual  in  deciding  his  occupation 
would  look  for  some  industry  which  would  produce 
something  for  which  there  was  a  great  demand.  Few 
people  would  produce  knitting  needles  and  many 
would  produce  wheat  so  that  the  demand  for  wheat, 
which  is  general,  would  be  satisfied  simply  because  the 
very  extent  of  the  demand  would  encourage  a  great 
number  to  engage  in  farming.  Similarly  the  demand 
for  clothes  would  encourage  a  great  production  of 
clothing  materials,  whereas  the  small  demand  for, 
let  us  say,  picture  frames,  would  only  attract  a  small 
number  of  producers. 

Even  if  we  admit  this  argument,  however,  there 
would  appear  to  be  a  danger  that  while  the  general 
necessities  would  receive  plenty  of  attention  from 
producers,  the  less  essential  but  still  desirable  goods 
would  be  neglected. 

Limitation  to  Demand  for  Necessities  —  The  demand 
even  for  necessities,  however,  is  not  unlimited.  There 
comes  a  time  when  the  demand  for  food,  even,  slackens. 
If  every  one  is  engaged  in  producing  food,  there  will 
only  be  food  produced  and  consequently  there  will  be 
no  production  of  clothing  or  other  goods.  How  is  the 


32      AN  INTRODUCTION  TO  ECONOMICS 

proper  relation  between  the  production  of  different 
requirements  to  be  met? 

The  Idea  of  Competition  —  Let  us  suppose  that  a 
given  individual  is  engaged  in  producing  wheat.  He 
finds  after  a  time  that  there  is  a  great  deal  of  other 
wheat,  besides  his,  in  the  market.  If  the  total  amount 
is  still  insufficient  for  the  needs  of  the  community,  he 
can  still  reap  all  he  requires  in  the  way  of  exchange  for 
his  surplus.  But  if  the  amount  is  greater  than  is 
required,  then  he  must  tempt  buyers  to  buy  his  own 
particular  portion.  To  do  this,  he  must  reduce  his 
price.  But  he  is  not  the  only  one  who  has  wheat  for 
sale.  Others  also  are  tempting  buyers  by  reductions 
in  price.  If  the  supply  of  wheat  continues  in  excess 
of  the  requirements  of  the  buyers,  the  price  will  steadily 
fall.  A  time  will  come  when  the  price  is  reduced  to  a 
point  where  the  sales  will  not  provide  sufficient  for  his 
own  needs.  In  other  words,  his  profit  will  disappear. 
All  wheat  sellers'  profit  is  not  the  same.  Some  have 
better  farms  than  others ;  some  are  nearer  the  market 
than  others,  or  have  some  special  advantage.  Hence 
some  of  the  wheat  producers  can  afford  to  take  a 
smaller  price  than  others  and  still  make  a  profit. 
In  the  case  of  the  individual  with  whom  we  are  dealing, 
we  will  suppose  that  the  point  of  vanished  profits  is 
reached.  It  does  not  pay  him  any  longer  to  produce 
wheat.  He,  therefore,  turns  his  attention  to  some 
other  industry  where  there  appears  to  be  chance  of  a 
greater  profit. 

The  results  of  this  change  are  twofold.  First,  there 
is  a  falling  off  in  the  production  of  wheat.  This  is  as  it 
should  be,  for  it  was  evident  that  the  supply  o!  wheat 


THE  COMPETITIVE  SYSTEM  33 

was  too  great  for  the  market.  There  will  be  other 
producers  in  the  same  position  as  the  individual  we  have 
been  considering,  so  the  fall  in  production  will  amount 
to  that  portion  of  the  wheat  supply  which  was  produced 
by  those  who  are  now  relinquishing  farming.  The 
result  will  be  that  the  others  who  still  continue  the 
production  of  wheat  will  be  enabled  to  gain  a  price 
for  their  product  sufficient  to  repay  them  for  the 
trouble  and  expense  of  producing  it. 

Second,  there  will  be  an  increase  in  the  production 
of  some  other  article,  the  price  of  which  had  formerly 
been  high.  This  is  naturally  the  case,  since  those  who 
have  given  up  farming  will  tend  to  choose  that  occupa- 
tion which  offers  the  greatest  returns.  The  fact  that 
they  so  choose,  however,  means,  as  we  have  said,  an 
increase  in  the  production  of  that  article,  and  conse- 
quently the  buyers  will  have  a  larger  supply  to  satisfy 
their  needs.  As  this  supply  increases,  the  producers 
will  bid  against  each  other  for  the  custom  of  the  buyers 
and  there  will,  therefore,  occur  a  fall  in  price. 

Meaning  of  Competition  —  It  must  be  noted  that 
the  competition  which  exists  is  between  producers  of 
the  same  article  and  between  buyers  of  that  article. 
The  producers  compete  with  each  other  when  the  supply 
is  large  by  reducing  their  prices,  and  so  encouraging 
buyers  to  satisfy  their  requirements  from  him  who 
offers  the  cheapest  rate.  When  the  supply  is  small, 
on  the  other  hand,  the  buyers  compete  with  each  other 
by  offering  increased  prices,  and  so  lead  the  producers 
to  sell  to  him  who  offers  the  highest  price.  No  com- 
petition occurs  between  producer  or  seller  and  buyer. 
They  are  in  quite  different  categories. 


34  AN  INTRODUCTION  TO  ECONOMICS 

Labor  Viewed  as  a  Commodity  —  Now  let  us 
consider  this  system  from  another  point  of  view.  How 
does  competition  affect  the  relations  between  employer 
and  employee?  For  the  moment  we  may  consider 
labor  as  being  a  commodity  just  as  wheat  is.  Later 
on  we  shall  find  that  labor  cannot  be  so  treated  entirely, 
but  in  the  meantime  the  supposition  will  not  affect 
our  argument.  If  the  supply  of  laborers  is  large,  then 
there  will  be  a  tendency  for  the  laborers  to  compete 
with  each  other  for  the  existing  jobs.  Each  looking 
after  his  own  interests  will  offer  to  work  for  a  smaller 
wage  in  order  to  obtain  employment.  If  the  supply 
of  labor  should  be  small  and  less  than  the  demand  for 
laborers,  then  the  employers  will  compete  with  one 
another  for  the  laborers  by  offering  higher  wages.  It 
should  be  noticed  here,  again,  that  there  is  no  com- 
petition between  laborer  and  employer.  There  is 
competition  between  workman  and  workman,  and  again 
between  employer  and  employer. 

Claims  Made  for  the  Competitive  System  —  It  is 
claimed  for  this  system  that  a  natural  equilibrium  will 
be  reached  in  which  ultimately  the  price  of  all  goods 
offered  for  sale  will  be  sufficient  to  remunerate  the 
producer  fairly,  neither  giving  him  too  high  a  profit  nor 
too  small  a  return ;  there  will  also  be  an  equilibrium  of 
wages  so  that  each  laborer  will  obtain  a  sufficient  sum 
to  keep  him  according  to  the  existing  standard  of  living. 
It  is  further  claimed  that  all  the  needs  of  society  will  be 
satisfied  in  exactly  the  right  degree,  according  to  their 
intensity.  That  is  to  say,  those  goods  which  are 
absolutely  essential  in  large  quantities  will  attract 
the  greatest  number  of  producers  and  those  which 


THE  COMPETITIVE  SYSTEM  35 

are  desirable  but  not  necessary  will  attract  compara- 
tively few. 

The  system  which  we  have  described  is  known  as  the 
competitive  system.  The  main  belief  which  lies  behind 
such  an  economic  organization,  or  rather  lack  of 
organization,  is  that  each  individual  looks  after  his 
own  interests  and  in  so  doing  the  needs  of  society  are 
best  met ;  that  if  the  natural  selfishness  of  the  individual 
is  allowed  full  play,  the  results  to  the  community  will 
be  better  than  if  the  governmental  organization 
attempts  to  regulate  production.  The  system  is 
sometimes  referred  to  as  the  laissez  faire  method. 
The  phrase  arose  from  the  expression  of  some  French 
economists,  that  each  should  be  allowed  to  make 
(laissez  faire)  what  he  pleased  and  allowed  to  go  (laissez 
oiler)  where  he  wished. 

Some  Defects  of  the  Competitive  System  —  Now  it 
will  be  at  once  recognized  that  the  description  given 
above  is  not  a  satisfactory  account  of  our  present 
organization.  There  are  many  modifications  which 
must  be  made.  In  the  first  place,  it  is  assumed  that 
each  individual  is  a  capable  judge  of  his  own  interests 
and  also  of  equal  strength  in  the  struggle.  TTiis  is 
obviously  not  the  case.  In  the  early  days  of  the 
industrial  revolution  it  was  soon  seen  that  the  weaker 
members  of  society  were  driven  to  the  wall.  The 
wages  of  the  father  being  reduced,  instead  of  the 
father  seeking  new  employment  in  some  other  industry, 
the  labor  of  the  children  was  called  in  to  assist.  Chil- 
dren were  set  to  work  at  as  early  an  age  as  four  years. 
Hours  of  labor  were  extended  to  an  almost  unbelievable 
degree.  It  was  not  uncommon  for  children  five,  six, 


36  AN  INTRODUCTION  TO  ECONOMICS 

or  seven  years  of  age  to  work  for  sixteen  hours  a  day. 
Women's  labor  was  also  abused.  We  do  not  now 
hear  of  women  working  as  beasts  of  burden  in  the 
coal  mines. 

Nor  was  the  system  satisfactory  apart  altogether 
from  the  position  of  the  laborer.  In  the  manufacturing 
world  also  the  system  failed  to  a  very  large  degree. 
A  factory  requires  a  considerable  amount  of  capital 
before  it  can  be  put  in  operation.  If  prices  are  so  low 
that  profits  disappear,  the  capital  invested  in  the 
business  is  to  a  very  large  extent  lost.  A  cotton  factory 
cannot  be  turned  into  an  engineering  plant.  It  may 
easily  happen,  for  example,  that  many  factories  are 
working  close  to  the  level  at  which  profits  vanish.  If 
prices  continue  to  fall,  not  one  factory,  but  many, 
must  close,  and  instead  of  production  being  reduced 
merely  to  a  natural  level,  the  production  will  almost 
cease  only  to  increase  to  an  undue  extent  when  the 
swollen  markets  are  exhausted. 

Failure  of  Competition  —  The  results  of  free  com- 
petition were  seen  best  in  the  early  part  of  the  nine- 
teenth century.  Laborers  were  badly  abused.  Em- 
ployment fluctuated  rapidly  between  overwork  and 
no  work  at  all.  Profits  also  alternated  between  high 
rates  and  the  vanishing  point.  Waste  of  capital  and 
effort  was  the  keynote  to  the  system.  Very  soon  it  was 
seen  that  competition  did  not  pay.  Manufacturers 
made  agreements  among  themselves  to  keep  prices  up, 
and  to  keep  costs  (principally  considered  to  be  made 
up  of  wage  costs)  down.  Workmen  endeavored  to 
do  the  same  and  keep  wages  up  by  combinations 
amongst  themselves.  In  other  words,  it  was  realized 


THE  COMPETITIVE  SYSTEM  37 

with  more  or  less  clearness  that  the  individual  could 
not  look  after  himself ;  he  was  forced  to  associate  with 
others. 

Nor  did  people  find  that  governmental  control  or 
other  alleviation  of  the  evils  of  the  system  could  be 
done  away  with.  Private  charity  helped  in  a  very 
slight  degree  to  remove  the  worst  of  the  abuses  resulting 
from  an  unbridled  individualism.  Natural  feelings  of 
sympathy  revolted  at  the  treatment  of  babies  in 
factories  and  domestic  workshops.  The  government 
was  forced  to  institute  or  amend  systems  of  poor  relief 
and  to  restrict  the  free  action  of  individuals  in  the 
conduct  of  their  work.  Factory  acts  and  education 
acts  were  passed  to  insure  an  improvement  in  the 
treatment  of  workers.  The  acts  limited  hours  of 
labor,  first  for  children  and  then  for  women,  and 
finally  for  men.  They  secured  healthier  conditions  of 
work  and  better  protection  from  dangerous  machinery, 
and  so  forth. 

Change  in  Principle  of  Government  Regulation  — 
In  the  main,  however,  there  was  a  distinct  change  from 
the  form  of  governmental  regulation  of  industry  from 
the  older  times.  Instead  of  regulating  the  nature  of 
the  product,  government  turned  its  attention  to  the 
manner  of  production.  There  was  still  freedom  to 
produce  what  a  person  wished,  although  there  is  a 
strong  tendency  for  the  government  at  present  to 
prohibit  trades  which  are  considered  to  be  harmful  to 
the  community. 

This  did  not  mean  that  the  idea  of  economic  freedom 
was  abandoned.  It  only  meant  a  better  interpretatipn 
of  the  word  freedom.  Freedom  can  only  exist  accom- 


38  AN  INTRODUCTION  TO  ECONOMICS 

panied  with  restraint.  We  do  not  consider  the  laws 
against  murder  and  theft  to  be  breaches  of  our  freedom. 
We  realize,  on  the  contrary,  that  without  such  laws 
we  could  not  be  free.  Freedom  means  the  right  to  do 
as  one  pleases  only  so  far  as  the  exercise  of  that  right 
does  not  infringe  upon  the  equal  right  of  our  neighbors. 
This  is  true  economically  as  well  as  generally.  It  is 
not  true  freedom  to  permit  one  individual  who  happens 
to  possess  certain  peculiar  advantages  to  impose  his 
will  on  all  others.  Government  exists  to  take  care  of 
the  welfare  of  the  community,  and  if  it  should  occur 
that  the  welfare  of  a  few  individuals  is  secured  at  the 
expense  of  the  rest,  government  must  intervene  to 
protect  the  majority. 

Experience  has  taught  us  that  pure  competition 
does  not  lead  to  the  best  results  in  solving  the  world 
problem.  The  system  we  now  live  under  shows  that 
there  is  a  definite,  if  gradual,  elimination  of  the  element 
of  competition  and  a  substitution  of  cooperation.  The 
cooperation  is  not  scientifically  ordered  as  yet,  however, 
and  it  tends  to  show  itself  in  the  organization  of  laborers 
into  trade  unions  for  the  purpose  of  collective  bargain- 
ing, and  of  employers  into  associations  tending  toward 
monopoly. 

Summary  —  We  may  sum  up  the  description  of  the 
modern  economic  system  by  saying  that  it  is  one  of 
modified  and  controlled  competition.  The  argument 
may  be  summarized  thus  : 

1.  The  wants  of  society  are  best  met  by  leaving  to  the 
individual  the  complete  right  to  produce  what  he  will. 

.2.  In  so  doing,  competition  will  regulate  the  production  in 
such  a  manner  as  to  secure  that  all  the  wants  of  society  are 


THE  COMPETITIVE  SYSTEM  39 

attended  to  in  the  proportion  which  they  are  desired,  pro- 
vided, however, 

3.  That  the  competition  be  restrained  by  various  modify- 
ing factors,  as,  for  instance, 

(a)  The  institution  of  private  charity ; 

(6)  The  institution  of  governmental  charity  in  the  form  of 
poor  relief,  public  hospitals,  etc. ; 

(c)  The  protection  of  the  weak  (particularly  women  and 
children)  by  governmental  regulation  of  the  conditions  of 
working ; 

(d)  Associations  of  workmen  or  employers  for  the  mutual 
protection  of  interests ; 

(e)  Government  ownership   and  operation   of   industries 
which,  from  their  nature  are  best  operated  as  monopolies 
(as,  for  instance,  the  Post  Office) ; 

(/)  Government  control  of  industries  which  have  tended  to 
become  monopolies  (railroads,  banks,  etc.). 

A  fuller  account  of  the  system  will  be  developed  in 
the  succeeding  chapters. 


CHAPTER  IV 

THE  MEANING   OF  PRODUCTION 

Physical  and  Conventional  Necessities  —  In  the 
past  chapters  we  have  spoken  frequently  of  necessities. 
The  word  has  not  an  absolute  meaning,  however;  it 
is  relative.  What  is  a  necessity  to  one  person  is  not 
always  such  to  another.  One  man's  meat  is  another 
man's  poison.  If  we  are  to  make  our  study  at  all 
thorough,  we  must  use  every  effort  to  define  our  terms 
so  that  there  shall  be  no  misunderstanding.  In  re- 
gard to  the  word  necessities  we  may  distinguish  two 
classes.  There  are  first  those  requirements  which  are 
essential  to  the  physical  life.  We  cannot  live  without 
food  anywhere.  In  most  climates  we  cannot  live  with- 
out clothing  and  shelter.  In  regard  to  all  three,  how- 
ever, the  amount  and  quality  of  each  vary  according 
to  conditions.  An  American  would  starve  on  the  diet 
of  a  peasant  in  India.  The  American  regards  certain 
articles  of  clothing  essential  which  an  Indian  would 
scorn,  although  living  in  the  same  climatic  conditions. 
The  skin  tent  or  the  adobe  hut  are  not  adequate  to 
the  necessities  of  the  white  laborer. 

Custom  has  a  great  deal  to  do  with  the  definition  of 
necessities.  What  we  are  accustomed  to,  we  come  to 
regard  as  being  absolutely  essential.  What  we  would 
like  to  possess,  but  are  not  accustomed  to,  becomes 
luxury.  For  example,  people  managed  to  get  to  their 
40 


THE  MEANING  OF  PRODUCTION  41 

work  by  walking  in  the  days  before  there  were  street 
cars.  A  conveyance  was  a  luxury.  Now  the  street 
car  is  an  essential  need  in  any  city.  To  those  who  are 
accustomed  to  traveling  in  underground  or  overhead 
railways  or  in  surface  cars,  automobiles  are  luxuries  — 
even  extravagances.  To  the  professional  classes  and 
the  moderately  well-to-do  business  man,  a  "  machine  " 
is  regarded  as  a  necessity. 

As  man  becomes  more  civilized,  the  number  of  his 
necessities  increases,  although  there  is  no  change  in  the 
physical  requirements  to  keep  him  alive.  We  may, 
therefore,  consider  the  second  class  of  necessities  as 
those  which  are  conventional.  That  is,  those  require- 
ments which  have  come  to  be  regarded  as  necessities 
because  those  who  so  regard  them  are  habituated  to 
them,  are  necessities  of  convention  or  of  custom  only. 
Without  them,  it  does  not  follow  that  the  race  would 
die  out,  or  even  the  individual  perish. 

Characteristics  of  Civilization  —  This  does  not  mean 
that  such  requirements  are  any  the  less  necessary  be- 
cause they  could,  at  a  pinch,  be  done  without.  When 
we  reach  a  state  of  civilization,  that  very  fact  is  evi- 
dence that  we  have  passed  out  of  the  stage  when  there 
was  only  a  step  between  existence  and  death  from 
privation.  And  the  higher  the  civilization,  the  greater 
is  the  distance  between  the  bare  level  of  subsistence 
and  the  actual  standard  of  life.  This  is  illustrated  all 
over  the  world.  Wherever  we  find  a  race  which  we 
consider  high  in  the  scale  of  development  we  find  a 
fairly  high  standard  of  living.  Or,  to  put  it  in  other 
words,  the  greater  is  the  number  of  conventional,  as 
distinguished  from  physical,  necessities. 


42      AN  INTRODUCTION  TO  ECONOMICS 

Great  luxuries  existing  coincidently  with  great  priva- 
tions does  not  mean  a  high  civilization.  Because  a  few 
can  satisfy  every  demand  that  their  nature  suggests, 
while  the  rest  live  in  sordid  poverty,  there  is  no  reason 
to  think  that  there  is  high  development.  What  we 
must  regard  is  the  general  standard  of  life  of  the  ma- 
jority of  the  people.  Luxuries  are  desirable  when  they 
can  be  widely  shared.  If  they  are  only  possible  to  the 
few  at  the  expense  of  the  necessities  of  the  many,  then 
they  are  to  be  avoided.  This  question  of  the  relation 
between  luxuries  and  necessities  will  be  dealt  with  more 
fully  later  on.  In  the  meantime,  we  are  more  con- 
cerned with  the  means  of  satisfying  the  general  neces- 
sities. 

Meaning  of  the  Term  Wealth  —  Our  desires  are 
satisfied  either  by  the  provision  of  goods  or  of  services, 
or  of  both.  Our  wealth  consists  of  the  number  or 
quantity  of  goods  and  services  which  we  can  command. 
In  our  study  of  economics  we  shall  have  occasion  to 
use  the  term  wealth  very  frequently.  Like  most  other 
terms  which  we  shall  use,  it  is  capable  of  many  mean- 
ings. Ruskin  defines  wealth  as  that  which  avails 
towards  health.  This  is  a  good  definition  from  Ruskin's 
point  of  view.  But  for  the  purposes  of  scientific 
measurement  we  cannot  use  such  a  definition.  For 
instance,  an  abundant  supply  of  air  and  sunshine  un- 
doubtedly tends  towards  health ;  indeed  it  is  essential 
to  health.  But  it  is  not  wealth  in  the  sense  in  which 
we  shall  use  the  word.  There  is  no  restriction  in  the 
supply  of  either  air  or  sunshine.  The  possession  of 
these  by  one  individual  does  not  in  any  way  restrict 
the  satisfaction  of  the  needs  of  any  other.  The  supply 


THE  MEANING  OF  PRODUCTION  43 

of  air  is  illimitable.  The  "  gentle  rain  from  heaven  " 
falls  alike  on  the  just  and  the  unjust.  Such  forms  of 
wealth  as  are  free  to  all  without  restriction  do  not  con- 
cern us.  We  can  only  deal,  in  our  present  study,  with 
those  forms  which  are  limited  in  amount. 

The  means  by  which  we  can  distinguish  one  form 
from  another  are  simple.  We  need  only  ask  ourselves 
the  question,  "  Would  we  be  willing  to  exchange  any- 
thing for  the  particular  form  of  wealth  we  are  con- 
sidering ?  "  For  instance,  take  the  case  of  that  form 
of  wealth  which  we  have  just  mentioned  —  air.  Would 
we  be  willing  to  offer  anything  for  the  air  we  breathe  ? 
In  ordinary  circumstances  we  would  not.  We  can 
obtain  all  we  want  without  the  necessity  of  offering 
anything  for  it.-  In  certain  circumstances  it  is  con- 
ceivable that  we  would  be  willing  to  offer  all  we  pos- 
sessed for  air.  But  those  circumstances  imply  a  re- 
striction in  the  amount  of  available  air  —  a  situation 
like  that  of  the  prisoners  in  the  Black  Hole  of  Calcutta, 
for  example.  This  only  proves  our  contention.  The 
same  is  true  of  water  also.  If  we  happen  to  live  by 
the  side  of  a  stream  of  pure  water  to  which  we  have 
easy  access,  we  will  offer  nothing  in  exchange  for  water, 
But  in  a  city  where  the  water  must  be  pumped  and 
led  through  pipes  and  perhaps  artificially  cleansed,  we 
are  willing  to  pay  a  price  either  to  a  water  company 
or  to  the  municipality.  The  restriction  in  the  supply 
makes  for  the  possibility  of  exchanging  one  form  of 
wealth  for  the  other. 

Wealth  Comprises  Services  as  well  as  Material 
Goods  —  Wealth  in  the  economic  sense,  therefore, 
consists  of  those  goods  and  services  whose  quantity 


44      AN  INTRODUCTION  TO  ECONOMICS 

is  limited.  It  will  be  noticed  that  the  word  goods  does 
not  stand  alone.  It  is  not  only  material  wealth  which 
is  economic.  When  we  are  hungry  we  satisfy  our 
hunger  with  material  wealth  in  the  form  of  food.  When 
we  are  sick  we  pay  for  the  services  of  a  doctor.  When 
we  have  trouble  with  our  neighbors  we  have  recourse 
to  the  services  of  a  lawyer.  If  we  desire  to  go  from 
one  city  to  another  we  make  use  of  the  services  of  the 
railroad  company. 

Utility,  Distinguished  from  Usefulness  —  In  short, 
whatever  is  necessary  to  satisfy  our  desires,  whether 
it  be  in  the  form  of  some  material  article  or  of  some 
service,  the  supply  or  availability  of  which  is  limited, 
we  consider  as  economic  wealth.  To  constitute  wealth, 
therefore,  there  must  be  a  certain  quality  of  useful- 
ness ;  the  article,  or  whatever  it  be,  must  satisfy  our 
want.  We  might  say  that  wealth  consists  of  those 
things  which  are  useful  and  limited  in  quantity.  But 
the  word  useful  has  disadvantages.  .  We  constantly 
use  it  with  a  certain  ethical  idea  in  our  minds.  To 
many  people,  for  example,  alcohol  as  a  beverage  is  the 
very  reverse  of  useful.  But  it  does  not,  for  that  reason, 
cease  to  be  economic  wealth.  It  satisfies  a  desire. 
Whether  that  desire  is  one  which  ought  to  be  satisfied 
is  beside  the  point.  The  fact  is  that  the  desire  exists 
and  that  alcohol  satisfies  it.  And  so  we  find  it  best  to 
avoid  the  use  of  the  word  with  the  ethical  implication 
and  choose  another  —  utility.  A  utility  is  something 
which  satisfies  a  desire. 

Consumption  of  Utilities  — In  the  satisfaction  of 
our  desires  we  consume  utilities.  The  main  process 
of  life  consists  of  consumption,  the  consumption  of 


THE   MEANING   OF   PRODUCTION  45 

utilities.  All  our  efforts  are  made  with  the  idea  of 
consumption  either  obviously  or  unconsciously.  The 
existence  of  a  desire  presupposes  the  means  to  satisfy 
that  desire.  In  consuming,  we  destroy.  What  is 
destroyed  must  be  again  produced  for  further  con- 
sumption. It  will  seem  at  first  glance  that  consumption 
does  not  necessarily  produce  destruction,  if  we  have  m 
mind  the  definition  of  utilities  which  was  given  above. 
We  do  not  destroy  the  railroad  carriage  which  takes 
us  across  the  continent,  or  the  street  car  which  takes 
us  to  business.  We  do  not  destroy  the  doctor  who 
eases  our  pain  in  sickness,  or  the  lawyer  who  argues 
our  case  before  the  courts.  Or  at  least  it  would  ap- 
pear so.  But  let  us  examine  the  matter  a  little  more 
closely.  Does  the  railroad  carriage  or  the  street  car 
last  forever,  even  if  it  meet  with  no  accident  ?  Sooner 
or  later  it  is  worn  out  and  unfit  for  the  service  it  has 
previously  rendered.  In  other  words,  for  the  purpose 
it  was  supposed  to  serve  it  is  destroyed.  It  has  been 
destroyed  in  the  course  of  satisfying  the  desires  of 
travelers.  Each  traveler  has  contributed  to  that  final 
destruction.  His  individual  contribution  is,  of  course, 
infinitesimally  small,  but  nevertheless  it  has  helped  to 
destroy  the  street  car.  Each  journey  by  each  indi- 
vidual, therefore,  consumes  a  portion  of  the  possible 
services  which  that  car  can  render.  Again,  in  the 
case  of  the  doctor,  the  small  amount  of  attention  that 
our  own  case  involves  does  not  seem  to  detract  from 
the  total  amount  that  the  doctor  can  give.  But  each 
doctor  is  capable,  in  his  lifetime,  of  only  a  limited 
amount  of  service  to  mankind.  Each  person  who  ac- 
cepts of  that  service  is  destroying  a  portion  of  the  total 


46  AN  INTRODUCTION   TO   ECONOMICS 

amount.  He  is  not  destroying  the  entire  usefulness 
of  the  doctor,  of  course.  But,  then,  a  man  is  not  de- 
stroying the  entire  loaf  when  he  eats  a  piece  of  bread. 

And  so  it  is,  also,  with  the  lawyer.  When  we  ask 
the  lawyer  to  plead  our  cause  before  the  jury,  we  ask 
for  a  certain  amount  of  his  time  and  energy  which 
cannot  be  replaced;  we  destroy,  therefore,  so  much 
of  his  service. 

Production  Determined  by  Consumption  —  It  does 
not  matter,  therefore,  whether  we  consider  utilities 
as  goods  or  services;  in  consuming  them  we  destroy 
them.  But  in  the  destruction  of  those  utilities,  our 
desires  are  satisfied,  and  that  is  the  end  which  we  had 
in  view.  It  is  our  desires  which  lead  to  the  production 
of  the  means  of  their  satisfaction.  All  our  production 
is  determined  by  our  desire  to  consume  something. 
This  statement,  again,  seems  to  be  contradictory  to 
the  facts  of  life.  Many  articles  are  produced  which 
seem  in  themselves  to  bring  into  being  the  desire  to 
consume.  Advertisers  are  often  heard  to  say  that 
they  create  the  desire  to  buy  articles.  If  this  be  true, 
then  the  articles  must  have  been  produced  before  the 
desire  existed,  and  it  would  seem  that  the  production 
preceded  the  demand  for  consumption,  or,  in  other 
words,  that  consumption  was  determined  by  produc- 
tion and  not  vice  versa. 

Let  us  examine  their  argument.  Take  the  case  of 
the  invention  of  the  typewriter.  Before  the  type- 
writer was  invented  every  one  was  content  to  do  all 
his  correspondence  by  hand.  No  writer  worried  about 
machines  for  writing.  There  was  a  definite  demand 
for  the  production  of  the  writing  instruments  then 


THE   MEANING  OF  PRODUCTION  47 

known,  the  pen  and  pencil,  for  example.  No  one  knew 
of  the  typewriter  and  hence  there  would  appear  to  be 
no  desire  to  "  consume  "  one.  When  the  typewriter 
was  invented  the  inventor  or  the  company  which  manu- 
factured it  had  to  create  a  wish  on  the  part  of  buyers, 
before  the  machine  could  be  sold.  The  typewriter 
was  manufactured  first  and  then  gradually  the  public 
was  led  to  see  its  advantages,  until,  at  the  present  day, 
no  company  would  attempt  to  carry  on  its  correspond- 
ence without  one  or  more  machines. 

Here,  it  would  appear,  is  a  distinct  case  of  produc- 
tion determining  consumption.  The  production  ap- 
peared first"  and  the  desire  to  consume  followed.  But 
is  this  actually  so  ?  Was  there  ever  a  time  when  writers 
'  were  perfectly  satisfied  with  their  instruments  ?  Were 
they  not  always  more  or  less  dissatisfied  with  their 
tools?  The  dissatisfaction  may  have  been  more  or 
less  unconscious,  but  it  was  there.  It  was  the  in- 
ventor who  realized  that  there  was  this  dissatisfaction 
and  who  sought  a  means  whereby  it  might  be  removed. 
In  other  words,  if  the  inventor  had  not  believed  that 
the  desire  for  a  more  perfect  writing  instrument  existed, 
he  would  never  have  devoted  his  labor  to  the  design- 
ing of  some  such  instrument.  If  he  had  thought  that 
no  one  would  buy  the  typewriter  when  he  had  perfected 
it,  he  would  not  have  invented  one.  The  cause  of  his 
invention,  therefore,  was  the  belief  that  there  was  a 
latent  desire  to  "  consume  "  the  machine  which  he 
could  design.  It  appears  therefore  that  the  contention 
that  consumption  in  this  case  was  determined  by  pro- 
duction is  only  justified  by  superficial  reasoning.  Con- 
sumption had  determined  the  production  of  the  in- 


48  AN   INTRODUCTION   TO   ECONOMICS 

strument  and  the  only  obscuring  feature  was  the  fact 
that  the  desire  was  latent  and  not  obvious. 

For  a  further  proof  of  the  argument  that  consumption 
determines  production,  we  may  consider  the  case  of  an 
invention  which  does  not  satisfy  a  latent  demand. 
Suppose,  for  instance,  some  inventor  produced  a  ma- 
chine for  the  purpose  of  tying  boot-laces.  He  might 
manufacture  the  machine  in  great  quantities,  but  the 
sales  would  never  justify  the  manufacture,  because 
the  demand  for  such  a  machine  does  not  exist.  There 
would  be  no  desire  to  consume.  In  this  case,  which 
is  by  no  means  uncommon,  the  inventor  has  made  a 
mistake  in  believing  that  there  was  a  latent  demand 
for  his  product.  Hence  his  production  is  a  failure. 
It  will  cease  before  he  has  manufactured  many  ma- 
chines. 

Successful  inventions  depend  upon  a  correct  realiza- 
tion of  a  latent  or  obvious  desire  to  consume  these 
inventions  as  much  as  upon  the  satisfactory  working 
of  the  invention  in  supplying  the  demand.  Our  desires 
to  consume  articles  which  as  yet  do  not  exist  are  in- 
finite. It  rests  with  the  discoverers  and  inventors  to 
find  these  desires  and  to  discover  a  means  whereby 
they  may  be  satisfied.  And  so  we  find  our  original 
view,  that  production  is  determined  by  consumption, 
to  be  correct. 

Definition  of  Production  —  So  far  we  have  used 
the  word  production  without  defining  it.  It  is  now 
necessary  that  we  make  clear  what  it  is  that  we  mean 
exactly  by  the  term.  In  common  use  there  is  a  limita- 
tion to  the  meaning  of  the  term  production  which  does 
not  exist  in  its  economic  use.  An  old  Irish  furniture 


THE   MEANING   OF   PRODUCTION  49 

manufacturer  used  to  say,  whenever  he  hired  a  new 
bookkeeper,  "  Another  non-producer  on  the  pay- 
roll." He,  in  common  with  many  other  people,  be- 
lieved that  the  only  actual  producers  were  those  who 
were  concerned  in  the  actual  handling  of  the  materials 
of  the  finished  product.  The  bookkeeper  probably 
never  saw  the  goods  until  they  were  finished  and  ready 
for  the  market;  indeed,  in  some  instances,  it  would 
be  true  to  say  that  the  bookkeeper  never  saw  the 
finished  product  at  all.  How  then  could  he  be  called 
anything  but  a  "  non-producer  "  ? 

Sometimes  a  still  more  restricted  meaning  has  been 
attached  to  the  word  production.  It  has  been  sup- 
posed that  only  those  who  are  engaged  in  the  actual 
extraction  of  the  product  from  mother  earth  are  the 
real  producers.  The  farmer  and  the  miner,  the  hunter 
and  the  fisherman,  would  then  appear  to  be  producers, 
while  the  miller  and  the  steel  manufacturer,  the  butcher 
and  the  fish  dealer,  were  merely  "  distributors." 

The  Miner  as  a  Producer  —  This  contention  also 
fails  upon  close  examination.  Let  us  consider  the 
case  of  the  miner,  for  example.  Nature .  provides  the 
mineral.  The  miner  extracts  that  mineral  from  the 
earth.  He  does  not  create  it.  All  that  he  does  is  to 
change  its  place.  In  the  earth  it  is  useless.  There 
are  vast  mountains  of  iron  ore  in  various  parts  of  the 
world  which  are,  at  present,  of  no  value.  Intrinsically 
they  are  just  as  valuable  as  the  iron  deposits  near 
Pittsburgh.  But  the  fact  remains  that  the  Pittsburgh 
deposits  are  worked  and  the  others  are  not.  The 
miners  have  removed  the  deposits  to  a  place,  i.e.,  the 
surface  of  the  earth,  where  they  may  be  of  service. 


50      AN  INTRODUCTION  TO  ECONOMICS 

But  let  us  suppose  that  the  miner  leaves  the  ore  in 
a  dump  at  the  mouth  of  the  mine.  Is  it  of  any  value 
there?  Obviously  it  is  not.  If  the  mineral  should 
be  coal,  it  must  be  taken  to  some  place  where  it  can 
be  burned  and  the  heat-value  obtained.  If  it  is  iron, 
it  must  be  smelted.  We  must  therefore  add  to  the 
producers  those  individuals  who  remove  the  ore  from 
the  surface  of  the  mine  to  the  place  where  it  can  be 
used,  or  who  smelt  the  ore  to  obtain  the  pure  metal. 

The  Steel  Manufacturer  —  Continuing  with  our  ex- 
ample of  the  iron  ore,  we  have  now  two  classes  of  pro- 
ducers, the  miners  who  dig  the  ore  out  of  the  mountain 
side  and  the  smelters  who  obtain  the  pure  metal.  Of 
what  value,  untouched,  is  the  pure  iron?  It  is  ob- 
viously unavailable  for  general  use,  say  for  the  making 
of  steel  rails,  or  of  cutlery,  until  it  has  been  transformed 
by  various  processes  into  steel.  And  the  steel  itself 
must  be  again  transformed  into  rails  and  knives,  or 
rolled  into  plates,  or  any  of  the  infinite  variety  of  forms 
in  which  we  desire  the  steel  to  be  changed.  Our  true 
producers,  therefore,  consist  now  of  the  miner,  the 
smelter,  the  steel  manufacturer,  the  maker  of  rails,  of 
cutlery,  of  steel  plates,  and  so  forth. 

The  "  Production  "  of  a  Ship  —  Now  go  a  step  further. 
This  time  we  will  work  backward.  Let  us  consider 
the  case  of  that  product  known  as  a  steel  ship.  As 
a  finished  product  it  consists  of  the  work  of  a  great 
variety  of  trades  and  of  a  great  number  of  different 
materials.  Take  the  materials  first.  We  shall  con- 
sider only  two,  the  steel  and  the  wood,  although  of 
metals  alone,  zinc,  copper,  aluminum,  brass,  bronze, 
tin,  and  many  others  are  used.  We  must  have  first 


THE   MEANING   OF   PRODUCTION  51 

the  ore,  produced  by  the  miner.  The  ore  must  be  re- 
moved from  the  mine  by  the  railroad  employee.  The 
smelter  changes  the  ore  into  metal.  The  cast-iron 
pigs  are  then  transformed  into  steel  which  is  cut  and 
rolled  into  many  forms.  It  is  shaped  and  punched 
again  for  riveting.  The  individual  pieces  are  assembled 
by  an  army  of  other  workers. 

The  wood  is  hewn  in  the  forest,  transported  by  river 
or  road  to  the  mill,  where  it  is  cut  into  various  shapes 
and  sizes.  It  is  further  shaped  and  erected  by  the  ship 
carpenters.  Now,  it  is  quite  unnecessary  to  enumerate 
the  variety  of  functions  performed  by  the  trades  con- 
cerned in  the  building  of  the  ships.  It  will  readily  be 
conceded  now  that  the  steel  manufacturer  is  as  much 
a  producer  as  the  miner,  and  the  shipwright  as  es- 
sential to  production  as  the  railroad  engineer.  They 
are,  then,  all  producers.  But  what  have  they  done 
to  earn  the  title  ?  The  miner  has  changed  the  location 
of  the  ore.  The  smelter  has  changed  the  form  of  the 
ore.  The  railroad  has  changed  the  location  of  the 
materials.  The  shipwrights  have  also  changed  the 
location  of  the  materials  by  erecting  them  into  a  hull. 

To  put  it  quite  briefly,  each  of  these  "  producers  " 
has  changed  something  either  in  form  or  shape  or  situa- 
tion. He  has  created  nothing. 

Agriculture  as  Production  —  Again,  take  the  case  of 
the  farmer;  he  creates  nothing.  Nature  provides 
for  the  creation.  The  farmer  merely  assists  nature  in 
changing  forms.  Carbon,  hydrogen,  nitrogen  exist  al- 
ready in  various  forms  and  in  various  groupings.  The 
farmer  assists  in  changing  the  forms  and  rearranging 
the  groupings  in  such  a  way  that  the  elements  may  be 


52  AN  INTRODUCTION   TO   ECONOMICS 

finally  consumed  by  man.  The  miller  does  not  create 
flour.  He  merely  changes  the  form  of  the  wheat. 
The  flour  existed  already  in  the  grain.  The  miller 
extracts  it  from  the  grain  and  removes  the  husks  so 
that  the  flour  may  be  suitable  for  baking.  The  rail- 
road conveys  the  flour  from  the  place  where  it  is  of  no 
value  for  consumption  to  the  place  where  it  can  be 
consumed.  All  those  who  contribute  in  any  way 
toward  preparing  the  elementary  substance  for  its 
final  form  and  bringing  that  final  form  to  the  place 
where  it  may  be  consumed  must  be  termed  producers. 

In  no  case  has  any  material  been  created.  What 
has  been  created  at  each  stage  of  production  is  a  new 
utility,  a  utility  of  form,  of  shape,  or  of  place. 

Production  of  Utilities  —  Now  this  puts  a  different 
complexion  on  the  argument  as  to  who  is  a  producer. 
We  have  seen  that  there  is  no  production  of  actual 
materials.  But  there  is  a  production  or  creation  of 
utilities.  Any  one,  then,  who  contributes  to  the  final 
form  of  consumable  wealth  by  producing  some  utility 
is  a  producer. 

How  does  this  affect  the  old  Irishman's  argument 
that  a  bookkeeper  is  not  a  producer?  What  utility, 
if  any,  does  the  bookkeeper  add  which  is  necessary  for 
the  final  product?  If  the  furniture  manufacturer,  or 
any  other  manufacturer  for  that  matter,  desires  to 
keep  turning  out  his  goods,  he  must  maintain  some 
record  of  the  materials  which  pass  through  his  hands, 
of  the  amount  due  to  his  laborers,  of  the  amounts  paid 
to  those  from  whom  he  buys  goods,  and  of  the  amounts 
received  from  those  to  whom  he  sells  the  goods.  With- 
out such  records  his  manufacture  would,  in  practice, 


THE   MEANING   OF  PRODUCTION  53 

be  impossible.  -The  bookkeeper,  therefore,  in  making 
those  records  is  adding  a  utility  which  is  absolutely 
necessary.  He  is  as  much  a  producer  as  any  of  the 
others.  They  merely  produce  utilities  —  not  ma- 
terials, and  the  bookkeeper  does  as  much. 

It  matters  not  what  industry  or  business  is  taken, 
the  same  result  will  be  found.  There  is  no  production 
of  materials,  but  a  vast  amount  of  production  of  utili- 
ties. And  so  we  may  say  that  the  train  dispatcher 
is  as  much  a  producer  as  the  locomotive  engineer  or  the 
conductor;  the  rate  clerk  as  much  a  producer  as  the 
track  layer,  or  the  engineer  who  designed  the  system 
or  built  the  bridges.  They  all  contribute  in  one  way 
or  another  toward  the  production  of  the  final  utility, 
a  transportation  system.  The  student  can  elaborate 
this  for  himself  and  so  convince  himself  of  the  truth  of 
the  argument.  But  it  will  be  advisable  to  carry  our 
illustrations  a  little  further  still.  In  what  way  are  we 
to  regard  our  doctors,  lawyers,  preachers,  artists, 
musicians,  and  so  forth  ?  Do  they  produce  anything  ? 
In  our  opening  argument  it  was  shown  that  consump- 
tion consisted  not  of  the  destruction  of  materials  only, 
but  of  utilities.  These  utilities  comprised  materials 
and  services.  Services  which  are  not  required  will 
soon  cease  to  be  offered.  If  we  have  with  us  doctors 
and  musicians  and  preachers,  it  is  because  these  are 
desired.  The  doctors  and  the  preachers  and  the  others 
are  doing  no  less  than  the  farmers  and  the  miners. 
They  are  producing  utilities,  and  hence  they  are  just 
as  much  entitled  to  the  term  producer. 

Summary  —  We  may  now  sum  up  the  argument 
contained  in  this  chapter  as  follows  : 


54      AN  INTRODUCTION  TO  ECONOMICS 

Economic  wealth  consists  of  those  goods  and  services  which 
are  desired  but  the  supply  of  which  is  limited.  We  can 
group  both  goods  and  services  under  the  title  of  "utilities," 
distinguishing  the  term  from  the  idea  of  usefulness  by  the 
elimination  of  all  ethical  interpretation. 

Utilities  exist  or  are  produced  for  the  sake  of  consumption. 
Consumption  means  the  destruction  of  utilities. 

The  production  of  utilities  is  determined  by  the  consump- 
tion, in  spite  of  an  appearance  to  the  contrary.  No  pro- 
duction will  be  successful  and  continuous  unless  there  is  a 
desire  to  consume. 

Just  as  consumption  means  consumption  of  utilities,  and 
not  merely  of  materials,  so  production  means  the  production 
of  utilities.  In  fact  there  is  no  such  thing  as  the  production 
of  materials,  in  the  sense  of  creation.  Form,  shape,  and  lo- 
cation of  materials  are  changed  by  the  creation  of  utilities. 

Hence  those  individuals  who  assist  in  the  creation  of  new 
utilities  must  be  termed  producers. 


CHAPTER  V 

THE  AGENTS   OF  PRODUCTION 

From  the  argument  in  the  previous  chapter  it  will 
be  seen  that  there  are  two  essential  requisites  for  all 
production.  First  there  are  material  requisites,  the 
gifts  of  nature ;  and  second,  there  is  the  labor  which  is 
applied  to  these  gifts  of  nature  in  order  to  make  them 
available  for  consumption. 

Meaning  of  the  Word  Land,  as  an  Agent  of  Pro- 
duction —  These  two  requisites  are  usually  termed 
the  agents  of  production.  The  first  of  the  two  is  com- 
monly summed  up  under  the  term  land.  It  is  very 
important  to  remember,  however,  that  the  word 
land  is  used  in  a  sense  very  different  from  the 
ordinary  meaning.  It  includes  not  only  the  dry  land, 
but  also  all  those  other  gifts  of  nature  which  furnish 
man  with  the  raw  material,  as  it  were,  of  his  necessities 
—  air,  sunshine,  rain,  heat,  and  so  forth.  This  wide 
meaning  given  to  a  simple  and  common  word  will  not 
involve  us  in  unusual  difficulties.  After  all,  the  natural 
forces,  unsupported  by  the  addition  of  directing  labor, 
are  free  to  all.  They  cannot  be  considered  as  economic 
wealth.  And  we  shall,  therefore,  tacitly  ignore  all 
but  the  material  meaning  when  we  use  the  word.  Land, 
then,  for  our  purposes,  will  be  taken  to  mean  the  earth, 
including  its  contents,  in  the  form  of  minerals,  etc., 
and  water  with  its  contents. 
55 


56  AN  INTRODUCTION   TO  ECONOMICS 

Meaning  of  Labor  —  The  other  requisite  for  pro- 
duction, labor,  is  equally  important.  Without  labor 
very  little  is  possible  in  the  way  of  production.  In- 
deed, if  we  regard  the  plucking  of  fruit  from  the  tree 
as  labor,  we  may  make  our  statement  still  stronger 
and  say  that  without  labor  no  production  is  possible. 
By  labor,  we  mean  every  effort  put  forward  by  man  to 
further  the  satisfaction  of  his  requirements.  We  are 
not  using  the  word  in  the  sense  of  manual  effort  only, 
as  it  is  commonly  used.  We  shall  find,  later  on,  that 
when  we  speak  of  "  labor  problems  "  we  are  dealing 
with  those  problems  which  affect  manual  laborers 
principally ;  but  in  general,  wrhen  the  term  labor  is 
used,  what  is  meant  is  the  more  general  idea  of  effort 
of  mind  and  hand,  in  short,  all  that  man  does  to  make 
available  for  consumption  the  materials  which  nature 
supplies. 

These  two  requisites,  then,  form  the  basis  of  our  dis- 
cussion of  the  agents  of  production.  But  labor,  in 
itself,  is  subdivided  into  two  classes.  First,  there  is 
the  actual  labor  which  is  exerted  at  any  given  time 
and  to  which  the  term  labor  is  in  practice  restricted. 
And  second,  there  is  what  might  be  termed  stored-up 
labor  but  which  is  usually  referred  to  as  capital. 

While  it  is  true,  to  a  limited  extent,  that  capital  may 
be  considered  as  stored-up  labor,  the  definition  is  not 
very  satisfactory  and  it  will  be  better  to  examine  the 
meaning  a  little  more  closely  before  we  attempt  to 
give  a  formal  definition. 

Meaning  of  Capital  —  Even  in  comparatively  primi- 
tive times,  man  usually  possesses  certain  more  or  less 
elementary  tools.  That  is,  he  has  made  instruments 


THE   AGENTS   OF   PRODUCTION  57 

not  for  the  satisfaction  that  he  can  obtain  from  them 
directly,  but  because  by  their  use  he  can  satisfy  his 
ultimate  desires  more  easily  or  more  abundantly.  Let 
us  examine  a  simple  illustration.  A  man  can  obtain 
a  drink  of  water  by  dipping  his  face  in  a  stream,  or  by 
scooping  up  water  in  his  hand.  In  this  case  his  "  labor  " 
is  direct.  Each  action  brings  an  immediate  consump- 
tion. It  is  easier  and  more  satisfactory  in  every  way 
to  use  a  cup.  But  a  cup  must  first  be  made.  The 
labor  involved  in  making  a  cup  is  not  expended  for  the 
immediate  satisfaction  of  some  desire.  It  is  expended 
for  the  purpose  of  facilitating  some  future  labor  which 
leads  to  the1  ultimate  satisfaction  of  the  desire.  Sup- 
pose the  stream  runs  some  little  distance  from  the 
dwelling  of  the  man.  Each  time  he  wants  to  drink 
or  to  obtain  water  for  any  purpose  he  must  go  down 
to  the  stream,  taking  his  cup  with  him.  If  he  wishes 
water  for  cooking,  he  must  go  to  the  stream  several 
times,  each  time  bringing  back  with  him  some  water 
in  his  cup.  A  little  additional  expenditure  of  inter- 
mediate labor  will  result  in  the  making  of  a  larger 
vessel,  which  he  may  fill  with  his  cup  at  the  stream  and 
so  save  several  journeys.  Still  further,  if  he  spends 
more  labor  in  the  intermediate  process,  he  may  con- 
struct a  runway  or  pipe  leading  from  the  higher  levels 
upstream  to  the  lower  level  of  his  house  and  so  avoid 
all  necessity  to  visit  the  stream.  With  each  of  these 
tools  or  appliances,  the  obtaining  of  wTater  becomes 
easier  and  more  satisfactory  in  amount. 

Appliances  made  for  the  purposes  of  facilitating 
production  and  not  for  immediate  consumption  we 
may  term  capital.  Now  carry  the  illustration  a  little 


58     AN  INTRODUCTION  TO  ECONOMICS 

further.  Suppose  the  man  decided  to  make  a  pipe. 
He  has  to  expend  effort  first  in  discovering  some  hollow 
trunks  of  sufficient  length  to  answer  his  purpose.  At 
best  the  result  will  be  only  partially  satisfactory.  If 
he  had  an  ax  or  a  saw,  he  would  be  able  to  produce  a 
much  better  pipe.  He,  therefore,  spends  sufficient 
time  and  energy  to  make  an  ax.  With  the  ax  he 
cuts  down  the  most  suitable  piece  of  lumber  and  shapes 
it  for  the  pipe  he  wishes  to  make.  Now  we  have  a  still 
further  example  of  the  application  of  labor  for  inter- 
mediate purposes.  The  ax  is  made  to  shape  the  pipe. 
The  pipe  is  made  to  lead  the  water.  Both  are  pro- 
duced with  the  idea,  not  of  immediate  satisfaction, 
but  in  order  to  make  the  ultimate  satisfaction  easier 
and  more  complete. 

This  simple  illustration  of  elementary  capital  may 
be  developed  to  explain  the  highly  complex  system  of 
modern  production.  But  instead  of  only  one  or  two 
intermediate  stages  in  production,  there  are  very  many. 
For  example,  take  the  printing  trade.  We  already 
have  miners  who  are  producing  steel  and  zinc  and  lead. 
They  do  not  wish  to  use  the  metals  themselves,  as  the 
ultimate  reason  for  producing  them.  These  metals 
are  to  be  used  for  the  making  of  printing  presses  and 
type  metal.  Lumbermen  are  felling  trees,  which  are 
turned  into  wood  pulp,  and  this  again  is  turned  into 
paper  to  be  used  in  the  printing  presses.  The  final 
article  to  be  consumed,  and  for  which  consumption  all 
the  preliminary  processes  have  been  carried  on,  is  the, 
newspaper  or  book.  In  each  case  the  intermediate 
product  is  a  form  of  capital.  It  is  a  form  of  wealth, 
the  object  of  which  is  not  the  immediate  satisfaction 


THE   AGENTS   OF  PRODUCTION  59 

of  some  desire,  but  the  facilitating  of  some  other  pro- 
duction which  has  for  its  aim  the  ultimate  satisfaction 
to  the  consumer.  Wealth  which  is  used  to  produce 
more  wealth  we  term  capital.  Wealth  which  is  to  be 
consumed  we  may  distinguish  as  consumer's  wealth. 

Capital  and  Consumer's  Wealth  —  It  is  often,  how- 
ever, very  difficult  to  distinguish  between  the  two,  as 
the  distinction  frequently  depends  upon  the  point  of 
view.  As  an  example,  let  us  take  the  position  of  a  man 
who  manufactures  printing  presses.  The  steel  and 
machinery  which  he  uses  in  turning  out  the  finished 
product  is  his  capital.  It  is  wealth  which  he  uses  to 
produce  more  wealth.  His  finished  product,  however, 
is  ready  to  be  consumed  by  the  printer.  From  the 
point  of  view  of  the  press  manufacturer  the  printing 
press  is  a  finished  product,  and  consequently  to  be 
regarded  as  consumer's  wealth.  But  that  is  not  the 
view  of  the  printer.  He  uses  the  press  to  print  his 
newspaper  or  book.  The  latter  is  the  finished  prod- 
uct, the  consumer's  wealth.  To  him  the  printing 
press  is  capital. 

Again,  a  real  estate  owner  who  has  a  number  of 
houses  which  he  rents  is  using  those  houses  as  his 
capital.  They  are  wealth  which  is  used  to  produce 
more  wealth.  He  does  not  consume  the  houses  him- 
self. But  the  individual  owner  of  a  house  in  which 
he  lives  is  using  that  house  for  the  final  consumption. 
He  is  getting  the  ultimate  satisfaction  out  of  the  house, 
the  provision  of  his  shelter  from  the  elements  and  of 
the  home  comforts  which  he  demands.  To  him,  the 
house  is  consumer's  wealth. 

The    distinction    between    capital    and    consumer's 


60     AN  INTRODUCTION  TO  ECONOMICS 

wealth,  therefore,  lies  in  the  use  to  which  the  wealth 
is  put.  Wherever  the  particular  form  of  wealth  under 
consideration  is  used  as  an  intermediary  in  the  pro- 
duction of  some  other  wealth,  it  is  capital.  Whenever 
it  is  regarded  as  satisfying  a  particular  want,  it  is  con- 
sumer's wealth. 

Classification  of  Forms  of  Capital  — The  wealth 
which  is  classed  as  capital,  however,  may  itself  be 
classified  into  several  varieties,  of  which  we  shall 
mention  the  two  most  important.  In  any  manu- 
facturing business  we  may  note  that  there  are  two  ele- 
ments at  least  in  the  enumeration  of  capital  in  the 
balance  sheet.  One  of  these  elements  is  the  plant, 
which  consists  of  the  buildings  and  machinery;  and 
the  other  is  the  stock  of  goods  on  hand.  In  a  furniture 
factory,  for  example,  part  of  the  capital  is  represented 
by  the  buildings  and  by  the  planing,  sawing,  and  turn- 
ing machines,  and  so  forth,  which  turn  the  wood  into 
furniture.  Another  part  is  the  wood  which  is  used 
in  the  furniture.  Now  there  is  an  essential  difference 
between  the  two.  The  wood  is  the  raw  material  of 
the  product.  Once  it  is  turned  into  furniture  it  is  in 
the  form  for  final  consumption.  That  wood  can  no 
longer  be  used  for  production.  If  the  factory  is  to  go 
on  producing,  there  must  be  a  fresh  stock  of  lumber 
obtained.  But  this  is  not  true  of  the  machinery.  The 
machinery  can  still  go  on  turning  out  dining-room 
suites  as  fast  as  the  wood  is  available.  Throughout 
the  whole  process  the  planing  machine,  the  jointer, 
or  the  saw  remain  the  same.  The  wood  changes  from 
raw  lumber  to  shaped  wood  and  finally  to  furniture. 
There  is  a  constant  circulation  of  wood  through  the 


THE   AGENTS   OF   PRODUCTION  61 

factory,  a  constant  stream  of  raw  wood  into  the  factory, 
and  as  constant  a  stream  of  furniture  out  of  the  factory. 

Circulating  and  Fixed  Capital  —  That  portion  of 
the  capital,  then,  which  circulates  through  the  factory 
is  termed  circulating  capital.  In  our  illustration,  the 
wood  used,  the  materials  for  polishing  and  staining, 
the  hinges  and  brass  work,  and  so  forth,  are  all  circu- 
lating capital.  That  whiqh  is  used  over  and  over 
again,  which  performs  the  same  functions  until  broken 
down  or  worn  out,  is  called  fixed  capital. 

In  the  modern  organj^tion  of  industry  the  out- 
standing feature  is  the  great  amount  and  importance 
of  fixed  capital.  It  is  largely  because  of  the  importance 
of  this  fixed  capital  that  we  speak,  sometimes,  of  the 
present  organization  as  the  capitalistic  system. 

The  further  back  in  history  we  go,  the  less  important 
becomes  the  fixed  capital  in  any  industry.  It  is  not 
so  very  long  ago  that  our  ancestors  obtained  their 
cloth  from  a  hand-loom,  woven  from  thread  spun  on  a 
spinning  wheel.  The  total  cost  of  both  instruments 
represented  a  few  dollars.  The  modern  system  in- 
volves an  immense  expenditure  in  the  provision  of 
large  buildings  containing  a  vast  number  of  spindles, 
other  buildings  with  very  many  looms,  and  still  others 
with  dyeing  vats,  all  operated  by  costly  engines  to 
supply  the  motive  power.  In  former  times  manu- 
facture was  literally  what  the  word  means,  the  making 
of  things  by  hand.  Now  it  means  the  making  of 
articles  by  machinery. 

Division  of  Labor  under  Capitalistic  System  —  Ob- 
viously there  must  be  some  advantages  in  the  present 
system  or  it  would  never  have  developed.  These 


62  AN  INTRODUCTION   TO   ECONOMICS 

advantages  are  to  be  sought  in  the  utilization  of  that 
principle  which  we  have  already  stated  to  be  one  of 
the  most  important  elements  in  economic  progress  — 
the  principle  of  division  of  labor.  The  capitalistic 
system  allows  a  very  full  development  of  that  principle. 
In  former  times  it  was  possible  for  a  man  to  have  the 
thread  for  his  clothes  spun  in  his  own  home,  woven  into 
cloth,  and  dyed  and  turned  into  suits  of  clothes  with- 
out leaving  the  dwelling.  *Now  some  men  (or  women) 
spend  all  their  time  doing  one  small  operation,  neces- 
sary, but  not  always  of  obvjpus  importance.  One  will 
card,  or  comb  out  the  wool;  another  will  turn  the 
wool  into  rough  yarn;  a  third  will  change  the  rough 
yarn  into  finer  thread.  The  cloth  is  woven  by  one  set 
of  workers,  dyed  by  another.  The  manufacture  of  the 
finished  cloth  itself  is  a  combination  of  many  different 
occupations. 

This  statement,  however,  does  not  explain  why  the 
multiplication  of  occupations  is  an  improvement  in 
production.  The  explanation  consists  in  an  elabora- 
tion of  two  very  common  sayings.  One  is  the  reference 
to  a  handyman  as  "  a  jack-of-all-trades  but  master  of 
none,"  and  the  other  is  the  advice  to  "  let  the  cobbler 
stick  to  his  last."  If  any  individual  tries  to  do  all  that 
is  necessary  for  himself,  he  does  nothing  particularly 
well.  We  often  hear  men  boasting  that  they  built 
their  houses  themselves.  As  a  rule  they  are  compli- 
mented with  the  reservation  that  the  house  is  a  good 
one,  considering  the  inexperience  of  the  workman. 
But  it  is  never  admitted  by  the  critics,  or,  indeed,  sug- 
gested by  the  workman,  that  the  result  is  as  good  as 
that  produced  by  the  professional  builder.  When  a 


THE   AGENTS   OF  PRODUCTION  63 

man  devotes  his  time  to  one  occupation  he  usually 
makes  a  better  job  than  if  he  divides  his  attention  over 
many  trades.  His  hand  and  eye  become  so  trained 
that  they  work  to  a  certain  extent  automatically.  The 
amateur,  on  the  other  hand,  has  to  work  each  detail 
of  the  operation  consciously.  Watch  a  small  child 
trying  to  fasten  a  button.  Each  step  in  the  operation 
(and  a  little  consideration  will  show  that  there  are 
several  steps)  is  performed  laboriously  and  slowly. 
When  the  child  is  older,  the  habitual  performance  of 
the  same  operation  has  brought  a  skill  that  is  auto- 
matic. The  individual  movements  which  are  neces- 
sary are  correlated  unconsciously.  Each  muscle  auto- 
matically performs  its  function,  and  the  speed  is 
infinitely  greater  than  at  the  beginning. 

This  is  true  of  every  operation.  Habitual  per- 
formance of  one  function,  while  it  may  have  dis- 
advantages which  we  shall  consider  in  a  later  chapter, 
nevertheless  results  in  a  great  increase  of  speed  and 
efficiency.  A  combination  of  experts  produces  a  much 
better-finished  article  and  produces  it  a  great  deal 
quicker  than  is  possible  for  one  man  performing  all 
the  operations  necessary. 

»  Hence  we  have  arrived  at  the  stage  in  our  economic 
evolution,  when  we  consciously  try  to  develop  new 
additions  to  our  occupations,  splitting  up  the  old  ones 
into  parts,  so  that  each  operation  consists  of  fewer 
movements,  better  coordinated,  and  all  with  the  view 
of  increasing  production  in  quantity  and  in  quality. 

It  is  partly  this  increase  in  specialization  which  has 
led  to  the  wonderful  development  of  mechanical  in- 
vention. The  individual  motions  necessary  in  the 


64      AN  INTRODUCTION  TO  ECONOMICS 

performance  of  a  given  function  have  been  so  simplified 
that  the  possibility  of  their  performance  by  machinery 
has  become  more  obvious. 

Scientific  Labor  —  There  has  even  been  developed 
a  science  of  production  which  aims  at  the  careful 
analysis  of  every  function  in  a  trade  in  order  to  elimi- 
nate waste  motion.  A  skilled  mechanic  is  asked  to  do 
a  piece  of  work  and  a  moving  picture  is  taken  of  the 
process.  Each  movement  of  hand  or  arm  or  head  is 
seen  in  the  film,  and  wherever  waste  or  unnecessary 
motion  is  apparent,  that  motion  is  eliminated.  We 
shall  have  occasion  to  criticize  this  method  of  studying 
production  later  on.  In  the  meantime,  it  suffices  to 
show  the  immense  importance  and  value  of  the  division 
of  labor. 

Specialization  in  Location  of  Industry  —  One  further 
consideration  must  be  noted.  Not  only  is  there  a 
specialization  of  occupation  in  regard  to  the  workers, 
but  also  there  is  a  specialization  of  locality.  Each 
district  tends  to  be  occupied  with  some  form  of  pro- 
duction for  which  it  is  peculiarly  suited.  The  middle 
west  is  more  suited  to  farming  than  to  manufacture. 
The  Pittsburgh  region  would  be  wasted  if  it  were  de- 
voted to  agriculture.  This  is,  of  course,  only  a  broad 
division.  In  agriculture,  some  districts  produce  wheat 
and  others,  cereals ;  others  grow  cotton,  others  oranges 
and  peaches.  In  some  manufacturing  districts  the 
attention  of  the  manufacturers  is  almost  wholly  de- 
voted to  the  production  of  automobiles,  in  others  to 
shipbuilding,  and  so  on.  The  student  can  easily  find 
examples  to  illustrate  this  territorial  division  of  labor. 

Industries    do    not    group    themselves    haphazard. 


THE   AGENTS   OF  PRODUCTION  65 

There  is  always  a  reason  for  their  existence  in  any 
given  locality.  The  making  of  any  kind  of  machin- 
ery depends  very  largely  upon  three  or  four  fac- 
tors. First  the  raw  materials  must  either  be  present 
or  readily  available.  Then  the  motive  power  must 
be  there,  either  in  the  form  of  coal  within  a  short  dis- 
tance, or  else  of  electric  power.  There  must  be  a  suf- 
ficient supply  of  labor  of  the  right  kind.  And  there 
must  also  be  ready  access  to  the  market  for  the  product. 
Historical  considerations  also  have  their  bearing  upon 
the  location  of  industry.  Sheffield  cutlery,  for  ex- 
ample, is  famous  all  over  the  world.  But  Sheffield 
has  not  now  what  would  be  regarded  as  exceptional 
facilities  for  the  production  of  high-grade  cutlery. 
Originally  the  industry  was  located  at  Sheffield  be- 
cause of  the  presence  of  a  certain  kind  of  stone,  known 
as  Sheffield  grit,  which  was  peculiarly  suitable  for 
grinding.  Iron  ore  was  also  close  at  hand.  Now  the 
cutlery  is  made  from  Swedish  ore  and  is  ground  with 
carborundum,  an  artificial  product.  The  associations 
of  the  past  have  kept  up  the  industry  in  the  present. 
It  must  always  be  remembered,  however,  that  his- 
torical associations  will  not  suffice  in  themselves  to 
keep  an  industry  in  a  certain  location.  In  former  times 
iron  smelting  always  took  place  near  a  forest,  for  the 
ore  was  smelted  with  charcoal.  Now  it  is  situated 
where  coal,  not  wood,  is  available.  The  economic  con- 
ditions must  always  be  suitable.  But  given  fairly 
satisfactory  economic  conditions,  historic  associations 
will  keep  an  industry  alive,  even  though  the  industry 
would  not  be  attracted  there  because  of  peculiar  ad- 
vantages. 


CHAPTER  VI 
THE  LAWS   OF  PRODUCTION 

Much  stress  has  been  laid  in  previous  chapters  on  the 
importance  of  the  principle  of  division  of  labor.  The 
whole  object  of  this  division,  as  has  already  been  seen, 
is  to  make  production  easier  and  more  economical. 
That  is,  we  have  secured,  in  this  principle,  a  means  of 
producing  much  more  rapidly  and,  very  frequently, 
much  better,  those  things  which  we  conceive  to  be 
necessary  for  our  existence.  Now  the  fact  that  we 
are  living  in  an  age  of  specialization  necessarily  means 
that  there  must  be  a  great  deal  of  exchange  of  sur- 
pluses. Each  produces  more  of  a  given  kind  of  wealth 
than  he  needs  for  his  own  consumption,  and  exchanges 
the  surplus  for  other  kinds  of  wealth  produced  by  his 
neighbors. 

Production  Stimulated  by  Profits  —  Obviously  each 
will  attempt  to  exchange  his  surplus  to  the  best  advan- 
tage; he  will  try  to  gain  as  much  by  his  exchanges 
as  possible.  The  more  he  obtains  by  exchanging  the 
surplus  of  his  own  product  the  greater  will  be  his  satis- 
faction in  that  production.  The  less  he  is  able  to  ob- 
tain by  such  exchanges,  the  less  will  be  his  desire  to 
continue  producing  that  particular  article.  If,  for 
example,  a  man  finds  that  by  producing  furniture  he 
can  exchange  his  surplus  for  all  the  other  products  that 


THE   LAWS   OF   PRODUCTION  67 

he  requires,  he  is  satisfied  and  goes  on  manufacturing 
furniture.  But  if  he  finds  that  every  one  has  already 
sufficient  furniture  and  that  consequently  he  is  not 
able  to  exchange  his  surplus  for  more  than  a  small 
fraction  of  his  other  needs,  then  he  will  cease  to  con- 
tinue the  business  and  will  seek  some  other  article  to 
produce  which  is  more  in  demand. 

His  production,  therefore,  will  depend  to  a  large  ex- 
tent upon  the  amount  of  wealth  that  he  can  gain  by 
exchange  of  surplus.  This,  of  course,  is  not  the  only 
reason  for  his  production.  There  are  many  others. 
He  may  be  satisfied  with  a  small  return  for  his  effort 
if,  for  example,  the  actual  production  itself  gives  him 
a  great  deal  of  pleasure.  An  artist  will  often  keep  on 
painting  pictures  although  he  could  gain  much  more 
by  drawing  posters  for  advertising  firms.  But  these 
other  reasons  for  production  will  occupy  our  attention 
in  a  later  chapter.  In  the  meantime  we  can  safely 
regard  the  desire  to  exchange  wealth  produced  by  the 
individual  for  other  kinds  of  wealth  produced  by  other 
workers  as  the  main  stimulus  to  production. 

Production  Secured  through  Application  of  Capital 
and  Labor  to  Natural  Resources  —  Now  all  production 
is  secured  by  the  application  of  two  of  the  agents 
which  we  discussed  in  the  last  chapter  to  the  third. 
Capital  and  labor  are  applied  to  natural  resources,  and 
the  result  is  the  creation  of  utilities  in  a  form  ready 
for  immediate  or  ultimate  consumption.  The  furni- 
ture manufacturer  applies  his  capital  and  the  labor  of 
his  workmen  and  himself  to  the  wood  and  other  ma- 
terials which  are  provided  by  nature,  and  the  result 
is  shown  in  tables  and  chairs  and  so  forth,  all  ready  to 


68  AN  INTRODUCTION  TO   ECONOMICS 

be  used  by  purchasers.  The  farmer  applies  his  capital, 
in  the  form  of  various  kinds  of  agricultural  machinery, 
barns,  dairies,  etc.,  and  the  labor  of  his  men,  to  the  land. 
The  result  is  the  production  of  food  for  the  people. 

Neither  the  farmer  nor  the  manufacturer  is  in  the 
business  "  for  his  health."  Each  calculates  with 
greater  or  less  accuracy  the  return  which  he  will  ob- 
tain for  his  expenditure  of  time  and  capital.  And  each, 
in  his  way,  will  try  so  to  use  that  capital  and  labor  as 
to  obtain  the  greatest  return. 

Necessity  for  a  Certain  Minimum  Capital  and  Effects 
of  Increases  —  Neither,  however,  will  attempt  to  com- 
mence production  without  a  certain  minimum  of 
capital.  If  the  farmer  starts  on  a  large  farm  without 
sufficient  capital,  he  soon  finds  that  his  production  is 
too  expensive.  The  returns  are  not  sufficient  to  justify 
what  expenditure  he  has  made.  In  other  words,  he 
finds  he  is  working  at  a  loss.  His  natural  remedy  is 
to  find  more  capital.  We  are  not  concerned  here  as 
to  his  methods  of  finding  the  additional  capital.  Find 
it  he  must,  however.  And  when  he  has  found  more 
capital  and  applied  it  and  the  result  justifies  his  efforts, 
he  immediately  wonders  whether  greater  results  can 
be  obtained  by  the  use  of  a  little  more  capital  or  by 
the  employment  of  a  few  more  laborers.  The  ad- 
ditional expense  of  irrigating  a  certain  field,  for  ex- 
ample, may  be  more  than  offset  by  the  increased  pro- 
duction from  that  field.  An  extra  hand  to  help  in  the 
plowing  of  another  field  may  mean  a  larger  harvest. 
Of  course  the  irrigating  of  the  field  or  the  employment 
of  the  laborer  will  mean  more  expense.  But  if  the  re- 
turns due  to  that  additional  expense  are  considerably 


THE   LAWS   OF  PRODUCTION  69 

greater  than  the  actual  expense  itself,  then  the  pro- 
cedure is  justified. 

Let  us  take  a  concrete  instance.  Suppose  a  farmer 
has  been  in  the  habit  of  using  horses  for  his  plowing. 
With  the  number  of  animals  he  possesses  he  is  able  to 
cultivate  one  half  of  his  land,  using  the  rest  for  pasture. 
By  the  addition  or  substitution  of  motors  he  believes 
he  could  cultivate  three  quarters  of  the  land.  The 
point  that  he  must  decide  is  this.  Will  the  additional 
crop  from  the  extra  quarter  be  of  sufficient  value  to 
pay  for  the  expense  of  buying  and  operating  the  motor 
plows?  If  so,  then  he  is  justified  in  considering  the 
purchase.  But  it  is  doubtful  whether  he  would  actually 
purchase  the  motors  if  he  thought  that  the  result  would 
only  be  sufficient  to  pay  for,  and  operate,  the  plows. 
There  must  be  an  increased  profit  to  make  the  actual 
purchase  worth  while.  If  by  the  use  of  his  existing 
means  of  production  he  is  able  to  gain  an  income  of  say 
$3000  in  a  year,  and  the  substitution  or  addition  of 
motor  plows  will  produce  an  income  of  $3500  and  also 
pay  the  annual  proportion  of  expense  of  purchasing 
and  maintaining  the  motors,  then  obviously  the  motors 
should  be  bought. 

Again,  if  he  is  considering  the  employment  of  more 
laborers,  he  must  estimate  the  amount  of  additional 
profit  which  would  result  from  the  addition  to  his  pay 
roll.  If  that  amount  is  greater  than  the  pay  of  the 
laborers,  then,  naturally,  it  pays  him  to  hire  the  men. 
If  the  new  profit  is  only  sufficient  to  pay  the  wages  of 
the  new  laborers,  he  is  not  justified  in  hiring  them. 

The  "  Dose  "  of  Capital  and  Labor  —  Still  further, 
it  may  not  be  a  case  of  simply  a  few  more  laborers,  or 


70      AN  INTRODUCTION  TO  ECONOMICS 

some  machinery.  It  is  quite  possible  that  both  are 
necessary.  It  is  usually  the  combination  of  the  two 
which  must  be  considered.  We  can  simplify  our  argu- 
ment, then,  by  taking  some  hypothetical  addition  of 
both  capital  and  labor  combined,  which  we  may  call 
a  dose  of  capital  and  labor.  We  must  remember,  of 
course,  that  the  idea  is  arbitrary.  There  is  no  such 
thing  as  a  uniform  application,  but  the  conception  is 
useful  for  the  purpose  of  argument. 

In  commencing  any  production,  then,  a  certain 
number  of  doses  of  capital  and  labor  are  essential  be- 
fore the  production  can  be  profitable.  With  one  dose 
the  return  would  not  be  sufficient  to  bring  any  profit. 
A  farmer  might  conceivably  start  farming  with  one 
horse  and  one  plow  and  the  labor  of  his  own  hands. 
But  he  would  not  make  much  of  a  success  of  the  farm. 
The  minimum  number  of  doses  to  be  applied  must  be 
sufficient  to  bring  what  may  be  termed  the  normal 
profit.  That  is,  it  must  be  sufficient  to  bring  as  much 
profit  as  its  employment  in  any  other  industry  would 
bring,  on  the  average.  To  make  this  quite  clear  let 
us  again  consider  a  concrete  example.  Suppose,  by 
the  application  of  a  given  number  of  doses  of  capital 
and  labor,  an  income  of  $3000  a  year  can  be  obtained 
in  many  different  industries  —  farming,  manufacturing, 
et  cetera.  Then  we  may  consider  that  the  normal 
return  from  that  number  of  doses  is  $3000.  Now  if 
the  application  of  a  further  equal  number  of  doses 
only  brings  an  additional  $3000,  then  the  addition 
has  only  secured  the  normal  profit.  But  if  this  addi- 
tional application  produces  a  return  of,  say,  $4000, 
it  is  quite  obviously  well  worth  applying. 


THE   LAWS   OF  PRODUCTION  71 

Each  individual  farmer  or  manufacturer  must  con- 
sider for  himself  when  the  application  of  additional 
doses  of  capital  and  labor  will  produce  an  increase  over 
the  normal  return.  There  are  times  when  it  will  and 
other  times  when  it  will  not,  and  the  occasions  will  vary 
from  industry  to  industry. 

Let  us  continue  our  illustration  of  the  farmer's  occu- 
pation. The  farmer  commences  with  the  minimum 
necessary  to  secure  the  normal  return.  Anything  less 
would  prevent  him  from  continuing  farming.  Almost 
invariably  he  finds  that  an  additional  dose  brings  a 
more  than  proportionate  increase  in  returns.  A  further 
dose  again  brings  in  additional  proportionate  increase 
and  so  on,  until  a  time  arrives  when  the  extra  increase 
over  the  normal  produced  by  one  more  dose  of  capital 
and  labor  does  not  amount  to  as  much  as  that  pro- 
duced by  the  previous  dose,  and  with  each  additional 
dose  the  return  above  the  normal  rate  falls  until  at 
last  a  time  is  reached  when  the  addition  of  one  more 
dose  only  produces  the  bare  normal  return. 

Law  of  Increasing  Returns  —  When  that  time  is 
reached,  it  is  time  to  stop  applying  any  more  capital 
and  labor  to  that  farm.  When  it  is  found  in  any  par- 
ticular industry  that  an  additional  dose  of  capital  and 
labor  produces  a  more  than  proportionate  increase  in 
return,  that  industry  is  said  to  be  subject  to  the  law 
of  increasing  returns,  or  increasing  productivity. 

So  far  we  have  considered  the  matter  from  the  point 
of  view  of  the  farming  industry.  This  is  not,  how- 
ever, the  best  illustration  of  the  action  of  the  law  of 
increasing  returns.  Most  farms  in  a  highly  organized 
community  have  ceased  to  be  subject  to  that  law. 


72  AN  INTRODUCTION  TO   ECONOMICS 

The  normal  profit  from  farming  is  that  represented 
by  those  farms  which  are  using  the  most  satisfactory 
amount  of  labor  and  capital.  In  the  manufacturing 
industries,  however,  the  law  is  better  exemplified. 
Many  small  factories  are  at  work  and  continuing  pro- 
duction with  a  fair  degree  of  satisfaction,  although 
an  increased  amount  of  capital  and  an  addition  to  the 
number  of  workmen  would  produce  a  proportionately 
greater  profit.  Every  one  has  heard,  at  one  time  or 
another,  complaints  of  small  manufacturers,  and  even 
of  larger  ones,  that  they  are  working  at  a  disadvantage 
from  lack  of  capital.  This  is  only  one  way  of  stating 
that  their  industries  are  subject  to  the  law  of  increasing 
returns.  The  manufacturers  imply  that  if  they  had 
more  capital,  or  could  obtain  more  laborers,  their 
profits  would  more  than  justify  the  additional  expense. 
Illustration  from  Ship-building  Industry  —  At  the 
present  time  a  very  good  example  is  found  in  the  ship- 
building industry.  The  demand  for  ships  is  very  much 
greater  than  the  supply.  Plant  after  plant  is  hampered 
in  its  production  by  the  fact  that  it  has  to  wait  for  the 
production  of  machinery  —  steel  punches,  drill  presses, 
shearing  machines,  and  so  forth.  All  these  represent 
capital.  If  they  were  able  to  obtain  these  machines 
more  rapidly,  their  production  would  be  increased  to 
such  an  extent  that  the  profits  reaped  would  very  much 
more  than  offset  the  cost  of  the  additional  machinery. 
The  same  is  true  in  respect  of  labor.  The  supply  is 
not  nearly  so  great  as  the  demand.  Many  more  work- 
men could  be  employed  and  the  profits  from  their 
labor  would  be  much  more  than  proportionate  to  the 
wages  paid  to  them. 


THE   LAWS   OF  PRODUCTION  73 

Law  of  Diminishing  Returns  —  But  even  in  manu- 
facture there  comes  a  time  when  the  law  of  increasing 
returns  ceases  to  operate.  As  the  demand  for  ships, 
for  example,  is  satisfied,  there  will  be  less  need  for  the 
production  of  new  ships.  The  prices  for  tonnage  will 
fall  and  profits  will  fall  with  them.  Hence  the  pro- 
vision of  more  capital  and  labor  will  be  less  and  less 
desirable.  Finally  it  will  be  undesirable,  in  that  the 
cost  of  the  additional  doses  will  be  greater  than  the 
returns  from  those  doses.  In  other  words,  a  time  comes 
when  the  reverse  law,  the  law  of  diminishing  returns, 
operates. 

Sooner  or  later  in  all  industries  the  law  of  diminishing 
returns  comes  into  play.  In  fact,  it  may  be  said  that 
the  operation  of  the  law  of  increasing  returns  represents 
a  temporary  condition  only.  It  works  up  to  a  certain 
point  and  when  that  point  is  reached  the  law  of  dimin- 
ishing returns  takes  its  place.  This  latter  law,  stated 
simply,  means  that  with  each  additional  dose  of  capital 
and  labor  applied  to  an  industry,  the  return  is  less. 
This  use  of  the  word  return,  however,  must  not  be 
understood  to  mean  the  money  reward  for  the  pro- 
duction. It  means  rather  that  the  net  amount  pro- 
duced is  less.  For  this  reason,  the  law  is  sometimes 
called  the  law  of  diminishing  productivity. 

In  the  case  of  a  farm,  for  example,  if  the  return  from 
one  dose  of  capital  and  labor  represents  one  hundred 
bushels  of  wheat  and  an  additional  dose  only  secures 
a  return  of  ninety  bushels,  then  the  law  of  diminishing 
returns  is  in  operation,  whereas,  if  the  new  return  had 
been  one  hundred  and  ten  bushels,  then  the  other  law, 
of  increasing  returns,  would  be  indicated. 


74 


AN  INTRODUCTION   TO   ECONOMICS 


The  law  of  diminishing  returns  begins  to  operate  long 
before  the  point  of  normal  returns  is  reached.  In  the 
foregoing  example,  for  instance,  it  may  be  supposed 
that  a  return  of  fifty  bushels  for  one  dose  of  capital 
and  labor  would  be  sufficient  to  justify  the  farmer  con- 
tinuing his  business.  If  that  were  the  case  he  would 
not  cease  to  add  doses  of  labor  although  the  return  to 
each  dose  was  less  with  each  addition.  As  long  as  the 
return  was  more  than  fifty  bushels  he  would  be  willing 
to  add  dose  after  dose.  But  in  time  there  would  come 
an  additional  dose  the  return  for  which  would  only 
be  forty-nine  bushels.  At  that  stage  there  would  be 
no  profit  on  the  increased  use  of  labor  and  capital,  and 
hence  there  would  be  a  definite  cessation  of  increases. 

Graphic  Illustration  —  Perhaps  the  whole  question 
can  be  made  more  distinct  by  a  visual  illustration. 


FtG.l. 

CURVE  To  ILLUSTRATE  THE.  Lt\ws  or  INCREASING 


THE   LAWS   OF  PRODUCTION  75 

The  application  of  the  laws  of  increasing  and  diminish- 
ing returns  may  be  illustrated  by  means  of  a  curve. 
Figure  1  represents  such  a  curve.  Along  the  line  OX 
each  division  represents  one  dose  of  capital  and  labor. 
Along  the  line  OY  each  division  indicates,  let  us  say, 
ten  bushels  of  wheat.  Let  us  assume  that  production 
commences  with  sufficient  capital  barely  to  justify 
its  application,  and  that  the  return  is  fifty  bushels  of 
wheat.  Along  OY  we  mark  the  point  B  which  is  five 
spaces  from  0.  This  represents  fifty  bushels  of  wheat. 
The  first  additional  dose,  let  us  say,  brings  a  return  of 
sixty  bushels.  From  the  first  division  along  OX  we 
count  up  six  spaces  and  then  mark  a  point.  Now  sup- 
pose that  the  returns  for  each  of  the  doses  of  capital 
and  labor  run  as  follows :  65,  70,  75,  80,  82,  84,  85, 
84,  82,  80,  75,  70,  65,  60,  50,  43,  35,  30,  28.  In  the 
same  way  as  before  we  mark  a  point  for  each  additional 
dose  indicating  the  return  from  that  dose.  Then  we 
join  the  points  and  obtain  the  "  curve  "  BECF. 

This  curve  represents  both  the  law  of  increasing 
returns  and  the  law  of  diminishing  returns.  The 
highest  point  reached  is  that  which  represents  the  re- 
turns for  the  eighth  dose.  From  that  time  onward 
each  dose  brings  in  a  less  return  than  the  previous  one 
and  so,  obviously,  the  law  of  diminishing  returns  is  in 
operation.  The  curve  up  to  the  point  E,  therefore,  rep- 
resents the  operation  of  the  law  of  increasing  returns  and 
from  E  onward  the  law  of  diminishing  returns. 

We  have  assumed,  however,  that  production  is 
justified  as  long  as  there  is  a  return  of  fifty  bushels 
from  each  dose  of  labor.  From  the  point  B,  which 
represents  a  production  of  fifty  bushels,  we  draw  a 


76      AN  INTRODUCTION  TO  ECONOMICS 

horizontal  line  BC  until  it  reaches  the  curve  at  the 
point  C.  This  line  represents  the  line  of  normal  re- 
turns. Any  dose  of  capital  and  labor  is  justified  whose 
production  reaches  this  line.  Hence  the  total  actual 
production  will  be  represented  by  the  area  included 
in  the  figure  OB  EC  A.  There  will  be  no  further  pro- 
duction after  the  sixteenth  dose,  because  the  return 
from  the  seventeenth  is  less  than  fifty  bushels. 

The  object  of  all  systems  of  production  should 
naturally  be  to  secure  such  an  application  of  the  avail- 
able capital  and  labor  that  all  industries  have  reached 
the  condition  represented  by  the  point  E  on  the  dia- 
gram. That  is  the  point  where  the  capital  and  labor 
have  been  utilized  to  the  highest  advantage.  Wherever 
the  law  of  increasing  returns  is  in  operation  there  will 
be  a  struggle  to  increase  the  amount  of  labor  and  capital 
applied  to  the  industry  so  that  the  utmost  production 
can  be  secured  from  the  effort  applied. 

Effect  of  the  Operation  of  the  Laws  of  Increasing 
and  Diminishing  Returns  —  Whenever  in  any  given 
industry  the  point  is  reached  where  the  law  of  diminish- 
ing returns  has  been  in  operation  long  enough  for  the 
returns  to  drop  to  the  minimum  required  for  normal 
profits,  then  there  will  be  a  tendency  to  divert  capital 
and  labor  from  that  industry  toward  some  other  where 
either  the  law  of  increasing  returns  is  in  actual  opera- 
tion, or  where  the  law  of  diminishing  returns  has  not 
progressed  to  the  point  of  normal  minimum  returns. 

In  the  following  chapter  we  shall  discuss  some  of  the 
methods  of  industrial  organization  which  have  been 
instituted  with  the  idea  of  making  the  most  economic 
use  of  capital  and  labor. 


CHAPTER  VII 

THE   ORGANIZATION    OF   PRODUCTION 

From  a  certain  point  of  view  the  heading  of  this 
chapter  gives  a  somewhat  wrong  impression.  Pro- 
duction in  our  modern  world  is  hardly  organized  at 
all;  it  is  rather  haphazard.  But  even  as  we  have 
seen  that  there  are  underlying  laws  which  give  a  sense 
of  unity  to  the  competitive  system,  so  we  may  see 
certain  rules  at  work  which,  while  they  do  not  amount 
to  a  definite  organization,  nevertheless  show  that  there 
is  a  certain  method  at  least,  which  takes  something 
from  the  haphazard  appearance. 

Distinction  between  Business  and  Industry  —  In  a 
former  chapter  it  was  shown  that  production  consisted 
in  altering  the  form,  the  shape,  or  the  position  of  wealth 
or  in  the  creation  of  services.  Production  may,  how- 
ever, be  roughly  divided  into  two  classes.  There  is 
that  form  of  production  which  consists  very  largely 
in  the  altering  of  the  form  and  shape  of  material  wealth, 
and  there  is  the  other  kind  which  consists  in  the  dis- 
tributing of  the  wealth.  The  common  terms,  Industry 
and  Business,  serve  to  designate  the  two  classes  with 
sufficient  accuracy  for  our  purpose.  Industry  is  re- 
lated principally  to  manufacturing  and  mining,  al- 
though for  the  purpose  of  this  rough  classification  we 
may  also  include  agriculture.  Business  is  concerned 
77 


78      AN  INTRODUCTION  TO  ECONOMICS 

with  the  exchanging  of  goods.  It  is  not  commonly 
considered  as  being  production,  but  in  the  sense  in 
which  we  have  defined  the  term  it  is  as  much  so  as 
any  other  form  of  economic  activity.  Business  pro- 
duces utilities,  and  that  is  all  that  is  done  by  the  in- 
dustries. • 

The  further  back  one  moves  into  the  historic  past, 
the  more  hazy  becomes  the  distinction  between  the 
two  classes.  Primitive  business  and  manufacture  were 
conducted  by  one  and  the  same  individual.  The  arrow 
maker  made  his  arrows  and  also  attended  to  the  ex- 
change of  his  product  for  that  of  the  hunter.  But  the 
further  one  moves  from  primitive  methods,  the  more 
does  the  principle  of  division  of  labor  operate.  Special- 
ization in  the  methods  of  exchange  increases  as  rapidly 
as  specialization  in  the  realm  of  industry. 

Early  Trade  —  There  is  much  that  is  interesting  in 
the  history  of  the  development  of  the  merchant  class 
and  of  its  methods.  The  early  chapman  or  peddler 
was  a  familiar  figure  in  the  times  when  Alfred  the 
Great  ruled  over  the  Saxon  kingdoms  in  England,  and 
Charlemagne  built  up  his  great  empire.  The  wander- 
ing merchants  from  far-off  countries  were  either  eagerly 
welcomed  or  driven  off  with  suspicious  hate,  according 
to  the  development  of  civilization  in  the  lands  which 
they  visited. 

Merchant  Fleets  —  Essentially,  however,  in  all  those 
early  examples  of  business  activity,  we  find  merchants 
working  almost  entirely  upon  their  own  capital.  They 
bought  the  goods  which  they  sold.  There  was  no 
commission  business  done.  Hence  the  amount  of 
business  done  by  one  particular  firm  or  merchant  was 


THE   ORGANIZATION   OF  PRODUCTION  79 

usually  small.  In  order  to  cope  with  larger  business, 
partnerships  were  necessary  and  they  developed  in 
their  own  fashion.  Merchant  trading,  especially  in 
oversea  traffic,  was  a  hazardous  occupation.  The  seas 
of  Europe  swarmed  with  pirates.  The  single  vessel 
owned  and  often  commanded  by  the  merchant  whose 
goods  it  contained,  was  seldom  a  match  for  the  swift 
galleys  of  the  pirates.  For  the  sake  of  protection  the 
individual  voyage.gave  place  to  the  voyage  of  the  mer- 
chant fleet.  At  regular  periods  the  Venetian  or 
Genoese  fleets  left  their  home  ports  in  the  Mediter- 
ranean to  sail  to  the  Levant  or  along  the  western  coasts 
of  Europe.  But  it  must  be  remembered  that  these 
fleets  consisted  not  of  one  individual  venture.  They 
were  a  unit  only  in  the  fact  that  the  ships  sailed  to- 
gether. Each  ship  was  a  separate  enterprise.  It  is 
true,  of  course,  that  as  trade  grew,  more  than  one  mer- 
chant was  associated  with  the  venture  in  a  particular 
ship. 

Formation  of  Partnerships  and  Companies  —  Tem- 
porary partnerships  were  arranged  where  the  fortune 
of  one  merchant  was  not  sufficient  to  fit  out  a  whole 
ship.  And  later  on  as  the  partnerships  grew  in  size 
perhaps  several  vessels  were  required  to  carry  the  goods 
of  the  partners.  Still  later,  it  was  found  that  more 
could  be  done  by  the  combined  efforts  of  large  groups 
of  merchants  whose  interests  lay  in  one  particular 
trade  than  by  the  individuals  who  composed  the  groups. 
Companies  were  formed  whose  objects  were  to  secure 
treaties  from  foreign  governments  and  to  provide  means 
of  securing  just  payments  for  goods  sold  in  the  lands 
which  the  fleets  visited. 


80  AN  INTRODUCTION   TO   ECONOMICS 

Indeed  at  the  ports  of  call  the  companies  had  their 
own  "  factories  "  which  were  not  factories  at  all  in 
the  modern  meaning  of  the  word.  They  were  rather 
storehouses  and  trading  stations.  Naturally  the  group 
of  merchants  who  formed  the  companies  had  to  have 
some  form  of  organization.  Rules  were  designed  to 
prevent  unfair  competition  between  the  members. 
Prices  were  standardized.  The  facilities  obtained  by 
the  companies  were  to  be  used  freely  by  all  members 
who  obeyed  the  rules  and  contributed  to  the  expense 
of  operation.  This  latter  consideration  of  expense 
was  important.  The  medieval  dukes  and  barons  and 
kings  who  granted  privileges  to  the  merchant  com- 
panies seldom  did  so  merely  out  of  a  wish  to  foster 
industry  and  commerce.  They  desired  some  cash 
payment,  and  the  cash  had  to  be  forthcoming  from 
the  companies  themselves.  And  having  obtained  their 
concessions,  the  companies  were  at  pains  to  keep  out- 
siders from  profiting. 

Monopolies  and  Regulated  Companies  —  They  at- 
tempted to  secure  monopolies  of  the  trade  from  their 
own  governments,  and  thus  arose  the  system  of  regu- 
lated companies.  In  return  for  a  consideration  the 
ruler  of  a  country  granted  a  monopoly  of  a  certain 
trade  to  a  company  whose  rules  were  more  or  less  sub- 
ject to  the  approval  of  the  government.  All  other 
merchants  of  the  country  were  forbidden  to  take  part 
in  the  trade.  As  an  illustration  of  these  companies, 
there  may  be  cited  the  Levant  Company,  which  re- 
ceived a  charter  from  the  ^English  king  to  trade  in  the 
spices  and  silks  of  Palestine  and  the  East ;  the  Mus- 
covite Company,  which  had  a  monopoly  of  the  trade 


THE   ORGANIZATION   OF  PRODUCTION  81 

to  Russia;  the  Merchant  Adventurers,  who  traded 
with  the  European  countries  bounding  the  North  Sea, 
and  so  forth. 

In  none  of  these  did  the  company  as  a  whole  do  any 
trading.  The  merchants  who  were  members  of  the 
company  traded  individually  and  were  only  associated 
together  in  order  to  secure  the  advantages  of  the 
monopolies  granted  to  the  company  and  of  the  treaty 
arrangements  which  it  secured. 

The  Chartered  Companies  —  Perhaps  the  whole 
system  may  be  better  explained  by  taking  an  example 
of  later  date  than  those  companies  mentioned.  The 
East  India  Company  obtained  a  **  charter  "  from 
James  the  First  to  trade  with  the  peoples  of  the  east 
coast  of  India.  The  company  established  "  factories  " 
at  Madras  and  later  on  at  Calcutta  and  Bombay.  It 
arranged  for  protection  and  freedom  to  trade  with  the 
Indian  princes  and  rulers,  and  bought  sufficient  land 
on  which  to  erect  its  warehouses.  The  merchants  who 
composed  the  company  did  an  independent  trade. 
Partnerships  were  common,  but  temporary.  That  is 
to  say,  each  ship  was  an  individual  venture.  Partner- 
ships would  be  formed  between  a  small  group  of  mer- 
chants to  fit  out  a  ship  to  sail  to  the  Indies.  When 
the  voyage  was  over  the  profits  were  divided  and  the 
partnership  ceased.  Naturally  there  was  a  tendency 
for  successful  partnerships  to  be  renewed  and  from  this 
tendency  arose  the  joint  stock  company.  Before  this 
can  be  discussed,  however,  it  will  be  well  to  consider 
the  advantages  and  defects  of  the  simple  partnership. 

Advantages  and  Defects  of  Partnerships  —  Partner- 
ships are  by  no  means  extinct.  They  exist  in  great 


82      AN  INTRODUCTION  TO  ECONOMICS 

numbers  to-day.  But  they  only  exist,  with  perhaps 
a  few  exceptions,  in  connection  with  small  businesses. 
Most  of  modern  business  is  done  by  large  concerns 
whose  capital  is  too  great  for  the  simple  partnership 
to  command.  The  partnership  arises,  however,  from 
the  fact  that  the  average  individual  possesses  insuf- 
ficient capital  to  carry  on  a  business  successfully  him- 
self. He  combines  his  capital  with  that  of  his  partner 
and  so  is  able  to  undertake  enterprises  which  each 
separately  could  not  finance. 

Obviously  there  is  a  distinct  advantage,  not  only  to 
the  partnership,  but  to  the  community,  in  this  arrange- 
ment. It  means  better  and  more  economical  use  of 
capital.  New  industries  become  possible  and  old  ones 
are  improved.  We  shall  notice  some  of  the  reasons 
for  such  improvement  in  the  next  chapter.  At  present 
it  is  sufficient  to  realize  that  the  principal  advantage 
resultant  from  the  combination  of  two  or  more  mer- 
chants is  the  possibility  of  widening  the  scope  of  opera- 
tions and  increasing  their  efficiency. 

Partnerships,  however,  have  distinct  disadvantages. 
In  the  first  place,  they  are  naturally  temporary.  They 
may  be  dissolved  at  will  or  at  the  death  of  one  of  the 
partners.  It  has  frequently  happened  that  a  good 
business  has  been  ruined  through  the  death  of  one  of 
the  partners  and  the  withdrawal  of  his  capital  by  the 
heirs  of  the  dead  man.  Again,  as  far  as  the  partners 
are  concerned  all  is  well,  perhaps,  as  long  as  the  business 
is  successful.  But  in  times  of  failure  it  may  mean  a 
great  deal  to  one  or  both.  For  example,  under  the 
laws  which  control  simple  partnerships,  the  partners 
are  each  responsible  for  the  debts  of  the  company  to 


THE    ORGANIZATION   OF   PRODUCTION  83 

the  full  extent  of  their  individual  resources.  If  one 
of  the  partners  is  a  wealthy  man  with  but  a  small  por- 
tion of  his  wealth  in  the  partnership  capital,  while  the 
other  has  all  his  capital  invested  in  the  one  business, 
on  the  failure  of  the  business  the  rich  partner  may  find 
that  the  whole  of  the  rest  of  his  wealth  is  drawn  upon 
to  pay  for  the  debts  of  the  company  which  has  only 
been  using  a  small  portion  of  his  capital.  To  put  the 
matter  in  concrete  figures,  let  us  suppose  that  two  part- 
ners engage  in  a  business.  One  of  them  supplies  $5000, 
which  is  all  the  funds  he  possesses.  The  other  also 
supplies  $5000,  but  has  additional  property  worth 
$50,000.  If  the  company  fails  and  the  debts  amount 
to  $20,000,  then  the  richer  of  the  two  partners  must 
pay  out  of  his  own  funds  the  $10,000  necessary  to  ful- 
fill the  obligations. 

Now  this  will  prevent  and  has  prevented  the  forma- 
tion of  many  partnerships  of  people  with  small  capital. 
A  man  will  not  invest  his  savings  in  a  business  when  he 
knows  that  he  may  be  called  upon  to  sell  his  home  to 
pay  the  debts  of  the  company,  in  case  of  failure.  Hence 
partnerships  are  usually  confined  to  those  who  are  able 
to  take  an  active  share  in  the  operations  of  the  business 
and  whose  capitals  are  more  or  less  equal. 

Early  Joint-stock  Companies  —  The  joint-stock  com- 
pany, as  it  used  to  be,  was  simply  an  extended  partner- 
ship. Many  men  combined  portions  of  their  individual 
capital  to  form  a  company.  The  company  was  directed 
by  certain  of  the  subscribers,  the  total  number  being 
too  great  to  take  a  direct  share.  Hence  the  whole  of 
the  fortunes  of  the  individual  investors  were  dependent 
upon  the  business  ability  and  success  of  those  who 


84  AN  INTRODUCTION   TO   ECONOMICS 

directed  the  work.  If  this  was  sufficient,  then  all  was 
quite  satisfactory.  But  if  the  directors  were  not 
skillful,  then  it  might  easily  happen  that  the  sub- 
scribers had  to  pay  for  that  lack  of  skill. 

Limited  Liability  —  The  remedy  for  this  grave  de- 
fect has  been  found  in  the  principle  of  limited  liability. 
Under  modern  corporation  laws  in  all  countries  the 
subscriber  of  capital  toward  the  formation  and  opera- 
tion of  a  company  is  limited  in  his  liability  to  the 
amount  of  capital  which  he  has  subscribed.  If  a  man 
buys  a  share  valued  at  a  hundred  dollars,  it  is  possible 
that  he  will  lose  all  that  he  has  paid  for  it.  But  he 
need  not  lose  any  more.  Should  the  company  which 
has  received  his  hundred  dollars  fail,  the  hundred  dollars 
will  probably  be  lost  either  entirely  or  in  part,  but  there 
is  nothing  to  require  the  subscriber  to  sell  any  other 
property  to  make  good  the  debts  of  the  company.  In 
banks  the  law  insists  upon  the  principle  of  double 
liability.  That  is,  the  subscriber  to  the  capital  of 
the  bank  may  be  called  upon,  in  case  of  the  bank's 
failure,  to  pay  an  additional  amount  equal  to  his 
original  subscription.  This  does  not  affect  the  princi- 
ple of  the  system,  however. 

The  value  of  the  idea  of  limited  liability  rests  upon 
the  fact  that  a  man  with  a  small  capital  may  use  that 
capital  by  lending  it  to  a  company,  knowing  that  his 
possible  loss  is  restricted  to  the  amount  he  invested. 

As  a  natural  result  from  the  development  of  the  use 
of  this  principle,  the  joint-stock  companies  have  grown 
to  such  an  extent  that  they  are  now  the  commonest 
form  of  commercial  and  industrial  organization.  They 
have  very  distinct  advantages  over  the  system  of 


THE   ORGANIZATION   OF  PRODUCTION  85 

private  partnership.  Apart  altogether  from  the  ad- 
vantage in  the  matter  of  liability  which  has  already 
been  mentioned,  there  is  the  great  improvement  in  the 
life  of  the  institution.  The  corporation  cannot  suffer 
from  the  withdrawal  of  a  partner.  A  partner,  i.e.,  a 
shareholder,  cannot  withdraw  from  the  business  un- 
less he  provides  some  one  to  take  his  place.  The  per- 
sonality of  the  new  partner,  moreover,  is  immaterial. 
The  stockholder  who  wishes  to  leave  a  company  must 
sell  his  stock.  The  purchaser  becomes  the  new  partner 
in  the  business,  but  the  policy  and  directorate  of  the 
corporation  remain  unchanged.  Only  in  the  case  of 
the  purchase  of  such  a  large  block  of  stock  as  to  give 
the  new  shareholder  a  decisive  voice  in  the  manage- 
ment of  the  company  may  the  policy  and  directorate 
be  changed.  It  is  assumed,  however,  that  the  greater 
the  amount  of  capital  subscribed  by  a  shareholder,  the 
greater  will  be  his  interest  in  the  success  of  the  company. 
And  so,  if  the  shareholder  acquires  what  is  called  a 
controlling  interest,  the  probability  is  that  he  will 
manage  the  business,  to  the  best  of  his  ability,  in  the 
way  which  will  bring  the  largest  returns  to  himself  and, 
presumably  also,  to  the  other  stockholders. 

Theoretically,  a  corporation  never  dies.  The  in- 
dividual shareholders  do,  of  course,  die,  but  their  place 
is  taken  by  others  to  whom  their  stock  is  left  or  sold, 
and  so  the  company  goes  on  doing  business.  Again, 
the  laws  require  always  a  certain  minimum  number 
of  directors  who  are  technically  responsible  to  the 
stockholders  for  the  conduct  of  the  business.  In  the 
multitude  of  counsel  there  is  wisdom.  It  is  assumed 
that  the  inexperience  of  one  director  will  be  nullified 


86  AN   INTRODUCTIQN   TO   ECONOMICS 

by  the  experience  or  skill  of  the  others.  On  the  whole 
it  may  be  safely  assumed  that  the  corporation  is  usually 
more  efficiently  managed  than  the  private  partnership. 

Government  of  the  Modern  Corporation  —  The 
development  of  the  corporation  form  of  business  is  in 
line  with  the  general  development  of  democratic  in- 
stitutions. There  is  a  distinct  analogy  between  the 
government  of  a  corporation  and  the  government  of  a 
democratic  country.  The  individual  stockholders  cor- 
respond to  the  individual  voters.  The  Board  of  Di- 
rectors is  similar  to  Congress,  and  the  Chairman,  to  the 
President.  The  Manager,  Secretary,  and  Treasurer 
correspond  to  the  Cabinet  officers.  Just  as  the  voters 
elect  Congress  and  the  President,  so  do  the  stockholders 
elect  the  Board  of  Directors. 

Bond  Issues  and  Bondholders  —  In  modern  times, 
however,  there  are  other  ways  in  which  a  corporation 
can  obtain  capital  than  by  securing  stockholders.  They 
may  borrow  directly  from  the  public.  Of  course,  it  is 
true  that  the  corporation  borrows  money  from  the  public 
when  it  issues  a  prospectus  and  obtains  subscriptions 
to  its  capital.  But  the  subscribers  become  direct 
partners  in  the  institution,  sharing  its  losses  as  well 
as  its  profits.  If  the  corporation  issues  bonds,  how- 
ever, the  bondholders  assume  no  responsibility  for 
the  losses  of  the  corporation.  They  simply  lend  their 
capital  for  a  definite  rate  of  interest  for  a  given  length 
of  time.  As  they  do  not  share  in  the  losses  of  the 
business,  they  do  not  share  in  its  management.  The 
management  lies  with  the  partners,  tha^t  is,  with  the 
stockholders.  As  long  as  the  bondholders  receive 
their  interest  and  the  principal  of  their  loan  is  not 


THE    ORGANIZATION   OF   PRODUCTION  87 

endangered,  they  have  absolutely  no  say  in  the  working 
of  the  corporation.  They  are  exactly  in  the  position  of 
mortgagees  who  have  lent  money  on  the  security  of  real 
estate.  The  mortgagee  is  not  concerned  with  the  way  in 
which  his  money  is  used.  He  is  satisfied  so  long  as  the  in- 
terest on  his  money  is  paid  regularly  and  the  property 
upon  which  the  money  is  lent  is  efficiently  safeguarded. 

Of  course  if  the  interest  is  defaulted,  or  if  the  prop- 
erty is  obviously  being  depreciated  so  that  the  ultimate 
security  of  the  money  lent  on  the  bonds  is  endangered, 
the  bondholders  may  step  in  and,  upon  due  legal 
process,  assume  control  of  the  business.  It  has  some- 
times happened,  indeed,  that  bondholders  have,  by 
various  methods,  secured  a  great  apparent  depreciation 
of  the  assets  of  a  corporation,  and  assumed  control  of 
a  corporation,  ultimately  buying  the  assets  of  the 
company  at  public  sale  for  a  very  small  sum.  No 
system  has  been  invented  so  far,  however,  which  is 
proof  against  unethical  forms  of  manipulation  in  the 
interests  of  individuals. 

Profits  of  Bond-  and  Stockholders  —  It  would  appear 
from  the  above  account,  that  the  bondholders  are  in 
a  much  better  position  than  the  stockholders.  Their 
principal  is  secured  as  well  as  their  interest.  Their 
interest,  however,  is  limited  to  the  stipulated  rate, 
while  the  profits  of  the  stockholders  are  limited  only 
by  the  earnings  of  the  corporation.  In  return  for  the 
risk  of  loss,  the  stockholder  gains  the  possibility  of 
higher  returns  upon  his  investment. 

Improvements  in  Production  Due  to  Corporation 
Form  of  Organization  —  The  great  advantage  which 
results  from  the  growth  of  the  corporation  form  of 


88  AN  INTRODUCTION   TO   ECONOMICS 

organization  is  the  possibility  of  working  in  large  units. 
It  is  not  unvaryingly  true  that  the  larger  the  unit  the 
better  the  organization.  It  will  be  noted  in  the  next 
chapter  that  the  law  of  diminishing  returns  operates 
in  the  organization  of  corporations  as  well  as  anywhere 
else.  Nevertheless,  the  older  organization  was  so  un- 
economical that  there  has  been  great  scope  for  the 
working  of  the  reverse  law  of  increasing  returns.  The 
older  system  meant  the  existence  of  innumerable  small 
organizations  with  the  attendant  waste  and  duplica- 
tion of  effort  which  characterized  them.  To  a  very 
large  extent  this  waste  can  be  eliminated.  It  has  not 
been  entirely  removed  as  yet.  No  one  with  any  real 
knowledge  of  the  working  of  our  modern  organization 
will  refuse  to  acknowledge  the  enormous  amount  of 
waste  of  effort  and  of  material  which  goes  on.  There 
is  more  talk  than  actual  realization  of  efficiency.  Still, 
there  is  undoubtedly  an  improvement.  The  larger 
units  have  eliminated  a  great  deal  of  the  waste.  To 
take  one  instance  alone,  it  may  be  shown  that  our 
modern  banking  system,  working  in  large  units,  closely 
interrelated  with  one  another,  is  infinitely  more  ef- 
ficient than  the  older  system  of  a  vast  number  of  private 
banks. 

Illustration  from  Banking  Business  —  The  early 
history  of  banking  in  the  United  States  shows  the 
existence  of  a  great  number  of  small  banking  houses 
frequently  working  with  an  unduly  small  capital.  In 
fact  there  are  instances  of  men  starting  banks  without 
capital  at  all  other  than  the  amount  necessary  to  rent 
a  room.  In  order  to  make  profits,  risks  which  were 
far  from  good  had  to  be  taken.  Rates  of  interest  too 


THE    ORGANIZATION   OF  PRODUCTION  89 

high  to  allow  conservative  business  men  to  avail  them- 
selves of  loans  had  to  be  charged.  The  natural  re- 
sults were  comparative  lack  of  assistance  to  good 
businesses,  and  overconfident  financing  of  speculative 
enterprises.  Failures  were  common.  The  credit  of 
the  country  rested  upon  a  wrong  basis.  Under  the 
modern  system  a  much  more  satisfactory  state  of 
affairs  is  apparent.  The  speculative  side  of  industry 
is  not  supported  by  the  banks  to  the  same  extent,  but 
larger  banking  resources  are  open  for  the  prosecution 
of  legitimate  commercial  enterprises. 

The  detail  of  these  banking  systems  will  come  up 
for  discussion  later.  At  present,  the  system  is  used 
merely  as  an  illustration  of  the  improvement  due  to 
the  corporation  system. 

Department  and  Chain  Stores  —  The  development 
of  the  great  department  stores  and  the  "  chains  "  of 
stores  is  another  illustration  of  the  elimination  of  waste 
and  the  securing  of  economies  through  the  corpora- 
tion system.  Large  capitals  are  necessary  to  these 
organizations.  And  large  capitals  cannot  be  obtained, 
except  under  very  exceptional  conditions,  from  a  few 
individuals.  Hence  they  must  be  the  result  of  the 
accumulation  of  small  investments  which  is  the  es- 
sential character  of  the  corporation  capital.  Even 
in  the  great  department  stores  there  is  waste,  only  too 
evident  to  those  who  manage  them.  But  the  waste 
there  is  infinitesimal  when  compared  with  what  pre- 
vails in  the  small  stores.  Small  stores  buy  their  goods 
at  a  disadvantage.  They  must  take  small  quantities 
at  a  time,  land  must  consequently  pay  the  high  prices 
inevitably  charged  for  small  amounts.  They  are  not 


90      AN  INTRODUCTION  TO  ECONOMICS 

in  a  good  position  to  judge  of  markets.  Their  own 
market  is  confined  to  a  small  radius  and  there  is  con- 
sequently little  possibility  of  goods  not  wanted  in  one 
locality  being  disposed  of  by  selling  them  in  another. 
The  department  store  reaches  a  much  wider  market 
and  can  afford  to  buy  in  much  greater  quantities  with 
the  certainty  of  being  able  to  dispose  of  a  much  greater 
variety  of  goods  than  can  the  small  dealer.  The  vary- 
ing wants  of  wider  markets  can  be  satisfied  with  less 
waste. 

The  village  tailor  can  only  have  a  small  range  of 
material  for  his  customers  to  choose  from.  If  he  has 
a  wide  range,  he  will  probably  find  that  much  of  his 
stock  remains  on  his  shelves.  Hence  his  customers 
cannot  satisfy  themselves  readily.  They  will  prefer 
to  deal  with  the  city  store  which  has  variety  to  satisfy 
all  tastes  and  which  can  nevertheless  turn  over  its 
stock  much  faster  than  the  village  tailor  can  hope  to 
do.  No  further  illustrations  are  necessary.  Common 
observation  will  furnish  infinite  numbers  to  prove  the 
truth  of  the  contention  that  the  large  capital  usually 
means  greater  efficiency. 


CHAPTER  VIII 
THE   ORGANIZATION   OF   PRODUCTION    (continued) 

It  is  not  only  in  business  that  great  strides  have  been 
made  during  the  past  century.  The  industrial  world 
has  moved  too,  and,  indeed,  shows  even  more  differ- 
ence from  the  crude  methods  of  the  past  than  does  the 
business  world.  Space  does  not  permit  of  an  exhaus- 
tive account  of  the  new  developments,  but  the  principles 
upon  which  the  present  organization  is  based  can  be 
indicated  without  occupying  too  much  of  our  attention. 

Agriculture  as  Industry  —  As  was  suggested  in  the 
last  chapter,  it  is  advisable  to  consider  agriculture  as  a 
branch  of  industry.  There  is  really  no  essential  dif- 
ference between  agriculture  and  manufacture.  The 
agriculturist  merely  applies  his  skill  and  knowledge 
to  the  changing  of  the  chemical  constituents  of  the 
soil  into  food  and  the  raw  material  of  fabrics.  The 
farmer's  aim  as  an  agriculturist,  apart  from  the  pri- 
mary necessity  to  obtain  profits,  is  to  produce  from  the 
soil  the  greatest  quantity  and  best  quality  of  crop  that 
can  be  obtained.  He  should  always  strive  to  improve 
his  production  in  both  directions,  and  his  success  may 
be  illustrated  by  reference  to  the  methods  and  results 
of  past  systems. 

Primitive  Agriculture  —  Primitive  agriculture  con- 
sisted of  a  simple  scratching  of  the  almost  virgin  soil 
91 


92  AN  INTRODUCTION   TO   ECONOMICS 

and  allowing  the  processes  of  nature  to  work  with 
little  assistance  from  the  farmer.  Even  as  late  as 
the  seventeenth  century,  the  highlander  plowed  the 
mountain  sides  in  Scotland  by  means  of  a  primitive 
implement  tied  to  the  end  of  the  ox's  tail.  The  actual 
origins  of  agriculture  are  doubtful.  Probably  man 
learned  very  gradually  that  the  growth  of  the  wild 
crops  could  be  stimulated  by  simple  tilling  of  the  soil, 
exposing  to  the  sun  fresh  earth.  With  this  as  a  basis, 
and  with  very  little  knowledge  of  the  effects  of  cropping 
upon  the  constituents  of  the  soil,  his  knowledge  was 
increased  by  experience  when  he  found  that  continual 
cropping  with  the  same  cereal  impoverished  the  soil. 
Various  methods  were  adopted  to  prevent  this  im- 
poverishment. Possibly,  as  the  farmer  wandered  from 
exhausted  fields  to  virgin  soil  he  arrived  in  his  wander- 
ings at  last  at  a  field  which  had  already  been  tilled  and 
left  upon  its  exhaustion.  He  discovered  that  in  the 
interval  during  which  the  land  had  lain  idle  it  had 
regained  its  fertility,  and  thus  arose  the  knowledge  of 
the  value  of  letting  land  lie  fallow.  Every  one  is  famil- 
iar with  the  biblical  method  of  allowing  one  year  in 
seven  to  the  soil  in  which  to  recover  its  resources.  The 
method  adopted  in  the  northern  parts  of  Europe  from 
which  our  ancestors  came  was  somewhat  different. 
There  the  cultivated  lands  were  divided  into  three 
parts,  two  of  which  were  tilled  each  year  while  one 
remained  fallow.  Each  of  the  "  fields  "  had  its  turn 
of  fallow  once  every  three  years. 

Communal  Tillage  —  The  lands  were  tilled  in  com- 
mon, although  not  necessarily  communally  owned. 
Each  of  the  cultivated  fields  was  divided  into  strips, 


THE    ORGANIZATION   OF  PRODUCTION  93 

separated  from  one  another  by  "  balks  "  of  grass  — 
strips  of  grass  from  four  to  six  feet  wide.  Each  of  the 
cultivators  possessed  the  produce  recovered  from  one 
or  more  of  the  strips.  When  the  crops  had  been  reaped 
and  the  cattle  fed  upon  the  stubble,  the  time  came  for 
the  re-cultivation  of  the  field.  The  strips  were  divided 
among  the  cultivators  again,  although  it  did  not  follow 
that  each  would  receive  the  same  strips  whose  produce 
was  his  property  in  the  previous  year. 

This  three-field  system  was  a  distinct  improvement 
over  the  old  system  of  continuous  cropping  to  the 
point  of  exhaustion,  but  it  was  nevertheless  wasteful. 
Moreover,  the  communal  method  of  operating  the 
land  made  it  almost  impossible  to  conduct  experiments 
for  improving  the  crops. 

Difficulties  in  the  Way  of  Progress  —  There  is  a 
general  feeling  that  farmers  are  a  conservative  class, 
hating  innovations.  That  may  not  be  true  at  present, 
particularly  in  America,  but  it  undoubtedly  was  so  in 
the  past.  And  when  there  came  a  farmer  sufficiently 
radical  to  suggest  a  new  method,  he  found  it  almost 
impossible  to  persuade  his  fellow  cultivators  to  agree 
to  the  "  new-fangled  "  idea.  Progress  was  only  possible 
when  experiments  were  made  upon  land  which  was  not 
included  in  the  three-field  system.  In  England  the 
system  broke  down  during  the  eighteenth  century. 
The  individual  farms  were  "  inclosed."  That  is,  each 
of  the  cultivators  became  the  possessor  of  an  amount 
of  land  roughly  equivalent  to  the  area  whose  produce 
he  had  formerly  received.  Then  the  individual  could 
experiment  for  himself,  if  he  so  wished,  without  con- 
sulting the  opinions  of  other  farmers.  It  was  during 


94  AN  INTRODUCTION   TO   ECONOMICS 

this  period  that  what  was  known  as  Dutch  culture  was 
inaugurated.  In  other  words,  continuous  cropping 
with  one  crop  gave  place  to  a  rotation  of  crops,  it  hav- 
ing been  found  that  what  one  crop  took  from  the  soil 
was  replaced  by  another. 

The  experiments  of  some  cattle  breeders  at  the  same 
time  improved  the  breed  of  cattle  to  an  extent  which 
seemed  almost  miraculous.  This  was  made  possible 
by  the  utilization  of  root  crops  for  winter  feed. 

Extensive  Culture  in  America  —  The  greatest  strides 
in  farming  methods,  however,  occurred  in  the  American 
continent.  Here  was  a  land  in  which  virgin  soil  seemed 
almost  inexhaustible.  Careful  tilling  was  not,  at  first, 
necessary.  The  size  of  the  farms  was  infinitely  greater 
than  in  Europe,  where  for  centuries  almost  every  avail- 
able acre  had  been  tilled.  When  a  larger  crop  was  re- 
quired, instead  of  manuring  the  existing  farm  land, 
fresh  virgin  soil  was  plowed  and  sown.  The  wide  area 
of  land  under  tillage  and  the  comparative  scarcity 
of  labor  tended  to  encourage  the  use  of  labor-saving 
machinery,  and  to-day  America  is  preeminently  the 
land  of  machine  farming.  Virgin  soil  no  longer  exists 
in  unlimited  acres.  Careful  cropping  is  necessary,  and 
the  wide  areas  cultivated  must  employ  the  best  of  the 
machines  in  order  to  provide  food  not  only  for  the  culti- 
vators themselves,  but  also  for  the  peoples  of  the  old 
world,  who  have  come  to  depend  very  largely  upon  the 
produce  of  America  for  their  daily  food. 

For  a  comparatively  long  period,  American  farms 
worked  under  the  law  of  increasing  returns.  Intensive 
culture  in  Europe  had  shown  that  land  could  be  im- 
proved in  quality  and  greater  crops  secured  by  the 


THE    ORGANIZATION   OF   PRODUCTION  95 

artificial  supply  of  chemicals  which  were  lacking  in 
the  soil.  But  Europe  had  reached  the  stage  where 
the  law  of  diminishing  returns  was  in  operation,  and 
although  the  powers  of  the  soil  were  improved  each 
addition  to  the  crops  cost  a  proportionately  greater 
expenditure  of  labor  and  capital.  America  learned 
from  the  experience  of  Europe,  and  vast  changes  have 
been  made  in  the  methods  of  agriculture.  Farmers 
have  at  their  service  the  best  knowledge  of  the  govern- 
ment experts,  and  the  universities  have  devoted  much 
attention  to  improving  methods  and  to  eliminating 
the  drawbacks  to  successful  cultivation. 

Increased  Use  of  Fixed  Capital  —  The  essential 
change  in  our  methods  of  agriculture,  however,  is  due 
ultimately  to  the  increased  amount  of  fixed  capital. 
The  simple  plow  drawn  by  horse  or  ox  has  given 
place  to  the  steam  or  gasoline  tractor  drawing  many 
plows.  Seeding,  harrowing,  reaping,  binding,  and 
threshing  are  all  done  by  machinery,  and  done  more 
economically  and  with  better  results  than  formerly. 

The  use  of  machinery,  while  it  has  proved  infinitely 
more  satisfactory  than  hand  labor,  has  not  diminished 
the  number  of  people  engaged  in  farming.  On  the 
contrary  it  has  increased  the  number  dependent  upon 
agriculture  for  their  living  to  an  enormous  extent.  It 
is  true,  however,  that  this  increase,  big  as  it  is  in  actual 
numbers,  is  not  proportionate  to  the  increase  in  popu- 
lation. Irrigation,  involving  an  immense  expenditure 
of  capital  and  labor,  has  brought  into  cultivation  areas 
which  used  to  be  deserts.  The  needs  of  a  growing 
manufacturing  community  have  demanded  an  increase 
in  production  which  has  made  it  profitable  to  apply  a 


96      AN  INTRODUCTION  TO  ECONOMICS 

new  army  of  agriculturists,  armed  with  the  best  weapons 
of  the  modern  scientific  farmer,  to  the  cultivation  of 
all  available  soil.  The  new  methods  have  lightened 
the  lot  of  the  farmer,  and  the  increased  means  of  com- 
munication, necessary  for  the  removal  of  his  produce, 
have  brought  him  into  closer  touch  with  his  neighbors, 
and  stimulated  him  mentally. 

Manufactures.  Subordinate  Nature  of  Early  Manu- 
facture —  Although  agriculture  has  made  great  strides  it 
is  in  the  manufacturing  side  of  industry  that  the  great- 
est changes  are  to  be  seen.  Formerly  all  manufacture 
was  carried  on  merely  as  an  adjunct  to  agriculture. 
Agriculture  was  the  mainstay,  and  a  limited  amount  of 
specialization  allowed  of  the  existence  of  trades  un- 
connected with  farming.  The  smith  and  the  carpenter 
did  not  devote  any  of  their  time  to  farming,  or,  at  least, 
devoted  very  little ;  but  the  spinning  and  weaving  of 
cloth  were  carried  on  by  the  farmers  themselves. 
Manufacture  then  meant  what  the  word  really  signifies, 
the  making  of  things  by  hand.  The  spinning  wheels 
and  the  hand  looms  were  hand  made.  They  were 
operated  by  hand  in  the  houses  of  the  working  people. 
Industry  was  domestic,  but  it  was  not  without  its 
organization. 

The  Gild  System  —  When  specialization  of  occu- 
pation grew  to  such  an  extent  that  trades  developed 
beyond  the  simple  blacksmithing  and  carpentering; 
when  the  butcher  and  the  baker  developed  their  crafts 
and  the  gold-  and  silversmiths  arose,  each  craft  at- 
tempted to  secure  the  welfare  of  those  who  carried  on 
those  industries.  They  united  in  organizations  which 
were  termed  gilds.  The  gilds  were  bodies  which 


THE   ORGANIZATION   OF  PRODUCTION  97 

comprised  all  who  were  engaged  in  a  particular  craft, 
or  trade.  They  were  organized  under  definite  rules 
which  provided  for  all  the  necessities  of  the  trade. 
Before  a  workman  could  be  admitted,  he  had  to  pass 
through  a  period  of  apprenticeship,  during  which  he 
lived  with  his  employer.  The  employer  undertook  to 
teach  him  the  craft  and  to  clothe  and  feed  him  while 
he  learned.  At  the  end  of  his  apprenticeship  he  be- 
came a  journeyman  and  looked  forward  to  the  time 
when  he  could  begin  business  himself  as  a  master.  The 
gild  included  those  in  all  three  stages  —  apprentices, 
journeymen,  and  masters.  Rules  prevented  one  master 
from  obtaining  more  than  his  share  of  the  amount  of 
work  to  be  done;  the  manner  of  the  work  done  was 
criticized  by  the  officers  of  the  gild  in  order!  to  main- 
tain good  standards  of  workmanship.  Competition 
was  not  allowed. 

The  sick  and  infirm  among  its  members  were  cared 
for  by  the  gild  funds,  from  which  also  the  orphans 
and  widows  of  deceased  members  were  aided. 

The  gilds  broke  down  very  largely  because  of  an 
ever  growing  strictness  in  the  rules  for  admittance.  No 
one  was  allowed  to  practice  a  craft  who  did  not  belong 
to  the  gild  in  his  district.  He  could  only  be  admitted 
to  the  gild  as  an  apprentice,  or  upon  payment  of  a 
heavy  entrance  fee.  Then  the  apprentices  were  charged 
fees  which  grew  to  such  an  extent  that  they  became 
almost  prohibitive.  The  gilds  became  close  corporations 
instead  of  free  associations,  and  the  resultant  outside 
competition  gradually  broke  down  their  organization. 

Manufacture  on  a  Small  Scale  —  Whether  organized 
in  gilds,  however,  or  working  as  free  individuals,  the 


98      AN  INTRODUCTION  TO  ECONOMICS 

workmen  carried  on  their  occupations  on  a  small  scale. 
Factories  did  not  exist,  although  as  early  as  the  fifteenth 
century  there  were  evidences  of  the  possibilities  of 
factory  organization. 

The  Factory  System  —  It  was  not  until  the  advent 
of  the  age  of  the  great  inventions  that  factory  organiza- 
tion came  into  being  to  any  great  extent.  The  latter 
part  of  the  eighteenth  century  saw  the  invention  of 
many  new  machines,  particularly  applied  to  the  textile 
trades,  which  rendered  necessary  the  grouping  of  work- 
men in  buildings.  The  change  from  the  older  system 
was  at  first  gradual,  but  toward  the  end  it  came  with 
increased  speed.  Under  the  older  method,  at  first,  the 
workman  owned  the  building  in  which  he  worked,  the 
tools  of  his  trade,  the  materials  from  which  the  product 
was  made,  and  he  supplied  the  power  from  his  own 
physical  energy.  He  gradually  came  to  work  upon 
materials  supplied  him  by  others.  Later  he  worked 
with  tools  lent  to  him  by  the  owners  of  the  materials. 
Still  later  those  same  owners  supplied  the  buildings 
in  which  he  worked  and  at  last  the  power  which  drove 
the  tools,  or  machines,  ceased  to  be  his  own  physical 
force,  and  was  derived  from  steam. 

Increased  Use  of  Fixed  Capital  in  Manufacture  - 
With  each  stage  of  development  there  is  seen  an  in- 
crease in  the  amount  of  fixed  capital  necessary  to  carry 
on  an  industry.  When  spinning  and  weaving  were  done 
by  hand,  the  tools  were  simple  and  every  peasant  had 
his  spinning  wheel  and  hand  loom.  When  the  spinning 
jenny  and  the  power  loom  were  to  be  used,  the  cost 
was  too  great  for  the  individual,  unless  he  possessed  a 
large  amount  of  capital.  The  workman  lost  more  and 


THE   ORGANIZATION   OF  PRODUCTION  99 

more  the  possibility  of  becoming  a  master  and  tended 
to  become  a  mere  wage  earner,  supplying  nothing  but 
his  physical  powers  and  his  skill  toward  the  manu- 
facture of  the  completed  product. 

With  each  stage  of  growth  there  is  seen  an  increase 
in  the  amount  of  production  from  the  individual. 
Each  stage  means  an  increased  use  of  the  principle  of 
division  of  labor.  With  every  additional  machine 
the  necessity  for  the  use  of  highly  skilled  labor  is 
lessened,  and,  as  a  consequence,  the  average  produc- 
tivity of  the  workman  is  increased.  Factory  organiza- 
tion is  not  profitable  unless  there  exists  a  market  for  a 
large  production.  Those  industries  which  command 
only  a  very  small  market  still  depend  upon  the  skill 
of  the  individual  workman. 

It  is  in  the  organization  of  industry  on  the  factory 
basis  that  the  best  examples  of  the  law  of  increasing 
returns  can  be  seen.  When  the  industry  is  on  a  small 
scale,  each  of  the  workmen  must  perform  the  greater 
number  of  the  operations  necessary  to  turn  out  the 
finished  product.  In  the  manufacture  of  furniture,  for 
instance,  if  the  work  is  done  in  a  small  workshop,  em- 
ploying perhaps  two  or  three  workmen,  the  amount 
produced  does  not  warrant  much  machine  work. 
Hence  there  is  a  great  deal  of  handwork  in  the  neces- 
sary planing,  sawing,  fitting,  etc.  Each  of  the  work- 
men divides  his  time  among  the  various  occupations. 
At  one  time  he  is  drawing  the  design  of  the  cabinet 
or  whatever  is  to  be  made.  Then  he  is  cutting  out 
the  different  shapes  which  he  must  proceed  to  plane 
and  fit  up.  Finally  he  smooths  the  whole  and  turns 
it  out  ready  for  polishing.  He  cannot  be  expert  at  all 


100  AN  INTRODUCTION   TO   ECONOMICS 

the  operations.  Or,  at  least,  he  cannot  be  as  expert 
as  one  who  spends  his  whole  time  in  one  operation. 

Under  the  factory  organization  the  shapes  can  be 
cut  by  machinery  in  large  numbers.  The  workmen 
necessary  to  operate  the  machines  are  few  in  com- 
parison with  the  amount  turned  out.  The  planing 
and  fitting  are  done  by  machinery  also,  and  likewise 
the  sanding  and  finishing.  If  the  expense  of  pro- 
ducing each  particular  part  of  the  finished  piece  of 
furniture  be  calculated  under  the  hand-work  system  and 
under  the  factory  system,  it  will  invariably  be  found 
that  the  cost  of  the  latter  method  is  very  much  less 
than  that  of  the  former.  On  the  whole  it  is  safe  to 
say,  also,  that  the  factory  work  will  be  better  done, 
provided  that  the  element  of  individual  artistry  does 
not  enter  into  the  product.  Each  of  the  workmen, 
aided  by  the  machines  specially  designed  to  perform 
functions  formerly  carried  out  by  hand,  acquires  a 
skill  and  speed  which  were  impossible  to  the  all-round 
cabinet  maker.  With  each  additional  application  of 
capital  and  labor,  then,  under  the  factory  system  of  or- 
ganization, it  can  be  shown  that,  up  to  a  certain  point, 
there  is  a  greater  productivity  both  in  general  and 
proportionately . 

But  this  is  only  true  up  to  a  certain  point.  There 
comes  a  time  when  the  factory  has  reached  its  limit 
for  satisfactory  production  and  the  law  of  decreasing 
returns  operates.  Managerial  ability,  for  instance,  is 
only  capable  of  handling  units  of  organization  of  a 
limited  size.  Experience  has  shown  that  when  a 
factory  has  reached  the  stage  when  further  expansion 
of  the  individual  unit  does  not  produce  a  proportion- 


THE    ORGANIZATION   OF  PRODUCTION          101 

ately  greater  return,   a  more  satisfactory  method  of 
production  is  to  organize  another  unit. 

Complexity  of  Modern  Trade  Forms  —  The  first 
of  the  economies  resultant  from  factory  organization, 
then,  is  the  increased  use  of  the  principle  of  specializa- 
tion or  division  of  labor.  The  Thirteenth  Census  of 
the  United  States  gives  a  list  of  over  one  hundred 
forty  different  forms  of  industry,  many  of  which  have 
within  their  own  limits  over  a  hundred  different  trades. 
The  cotton  industry  and  the  boot  and  shoe  industry, 
for  instance,  have  upwards  of  one  hundred  fifty  differ- 
ent trades. 

Elimination  of  Waste  —  The  second  economy  which 
is  a  direct  result  of  the  factory  system  is  the  elimina- 
tion of  a  large  amount  of  waste.  Goods  can  be  bought 
in  larger  quantities  and  can  be  more  skillfully  selected. 
The  better  parts  of  the  product  can  be  used  for  the 
more  important  portions  of  the  finished  articles. 
Waste  cut  from  the  better  goods  can  be  used  in  the 
construction  of  less  important  parts. 

Transport  is  economized  through  the  use  of  car- 
loads of  goods  instead  of  small  individual  orders.  Over- 
head expense  —  rent,  lighting,  heat,  office  service, 
and  so  on  —  is  much  less  per  unit  of  production.  By- 
products can  be  much  better  dealt  with  when  the  in- 
dustry is  on  a  large  scale  than  under  the  older  small- 
scale  organization. 

Problems  of  Production  —  The  problems  of  produc- 
tion have  not  been  decreased,  however.  They  are 
still  as  numerous  and  as  important  as  formerly.  But 
the  large-scale  production  has  made  possible  the 
scientific  attempts  at  solution  of  the  problems.  With- 


102  AN  INTRODUCTION   TO   ECONOMICS 

out  attempting  to  make  an  exhaustive  list  of  these 
problems,  the  main  elements  may  be  indicated. 

i.  Location  of  Industry  —  First  there  is  the  prob- 
lem of  the  location  of  the  industry.  Under  small-scale 
production  industries  were  scattered  far  and  wide  and 
little  attempt  was  made  to  locate  the  industry  in  the 
most  suitable  position.  Transport  being  badly  organ- 
ized, the  market  for  the  sale  of  goods  of  any  kind  was 
necessarily  small  and  hence  production  was  scattered 
over  a  large  number  of  small  units.  With  transporta- 
tion improved  (and  this  is  only  possible  where  there  is 
large  production  to  keep  the  systems  of  railroads, 
canals,  and  ocean  carriers  busy),  industries  could  select 
the  best  situation. 

In  deciding  the  location  of  an  industry  some  of  the 
points  to  be  considered  are  as  follows : 

First,  labor  must  be  available,  and  labor  of  the  right 
class.  It  would  be  folly  to  set  up,  say,  a  watch-making 
plant,  where  the  only  labor  available  was  that  of,  let  us  say, 
Indians. 

Second,  the  raw  product  must  be  easily  obtained.  Raw 
material  should  not  be  drawn  from  a  distance  unless  trans- 
portation is  cheap  or  unless  it  is  drawn  from  a  spot  where  the 
actual  manufacture  is  impossible  for  other  reasons,  as  in  the 
case  of  the  rubber  industry,  for  example. 

Third,  power  for  the  machinery  must  be  easily  obtained. 
This  means  proximity  to  coal  supplies  or  electric  power. 
Finally  the  markets  for  the  sale  of  the  goods  must  be  con- 
venient. This  does  not  necessarily  mean  that  the  markets 
should  be  near.  But  they  must  be  reached  without  undue 
expense  for  transportation.  In  the  early  years  of  the  eco- 
nomic history  of  the  United  States  human  food  products 
were  often  used  for  feeding  pigs,  as  the  cost  of  transporting 


THE    ORGANIZATION   OF   PRODUCTION          103 

them  for  a  greater  distance  than  twenty  or  thirty  miles  was 
so  great  as  to  make  thejprice  to  the  consumer  prohibitive. 

2.  Capitalization  —  The  second  problem  is  that  of 
capitalization.     The  funds  for  the  initial  expense  of 
commencing  the  industry  must  be  procured.     A  de- 
cision must  be  made  as  to  the  methods  of  financing  the 
new  industry.     This  is  a  matter  which  will  be  con- 
sidered in  greater  detail  in  the  next  chapter.     In  all 
probability  the  industry  must  be  run  with  borrowed 
capital.     That  is,  it  must  avail  itself  of  the  funds  of 
investors  who  look  to  a  return  on  their  investment 
without   themselves   contributing   much   time   to   the 
management. 

3.  Factory  Organization  —  Having  selected  the  site 
and  obtained  the  funds,  the  next  step  is  to  organize 
the  factory.     The  directors  of  the  corporation  will  be 
elected  by  the  stockholders.     They  in  turn  will  ap- 
point   their   president   and   officers.     Of    these   latter 
there  are  three  of  great  importance,  the  production 
manager,  the  office  manager,  and  the  sales  manager. 
The  production  manager  will  plan  very  carefully  the 
arrangement  of  alt  the  machinery  so  that  there  will 
be  no  waste  motions  in  sending  the  partly  finished 
product  from  one  machine  to  the  next.     He  will  decide 
the  number  and  grouping,  the  training  and  payment 
of  the  workers;     the  purchase  and  storing  of  the  raw 
materials  and  partly  finished  goods. 

The  office  manager  will  attend  to  the  accounting 
processes.  He  must  keep  track  of  all  disbursements  and 
receipts,  calculate  the  profits  and  losses,  so  that  a  clear 
presentation  of  the  state  of  the  business  can  be  made 
at  any  time. 


104  AN   INTRODUCTION   TO   ECONOMICS 

The  sales  manager  must  take  care  of  the  processes 
necessary  to  distributing  the  goods  to  the  consumers. 
He  will  control  and  train  the  sales  force,  arrange  for 
advertising,  and  so  forth.  Each  of  these  managers  is 
essential.  In  small  businesses,  of  course,  the  three 
may  be  included  in  one  individual,  but  the  larger  the 
business  the  more  necessary  is  it  to  specialize.  It  is 
seldom  true  that  the  most  efficient  production  engineer 
is  also  an  efficient  salesman  or  accountant.  And  the 
good  accountant  cannot  be  expected  to  have  an  expert 
technical  knowledge  of  the  manufacture  of  the  product 
of  the  business. 

4.  Scientific  Management  —  In  the  actual  methods 
of  production  there  is  room  for  improvement  in  a  great 
many  ways.  The  most  carefully  thought-out  method 
of  production  is,  perhaps,  that  of  those  who  have  de- 
veloped what  is  known  as  Scientific  Management. 
Under  scientific  management  the  production  is  first 
analyzed  into  its  main  parts.  Then  a  further  analysis 
is  made  of  each  part  until  finally  the  individual  motions 
of  the  workman  are  considered. 

An  expert  workman  is  set  to  perform  his  usual  task. 
While  he  is  at  work  every  action  is  noted,  sometimes 
moving-picture  records  being  taken.  Wherever  waste 
effort,  useless  motions,  or  strain  of  any  kind  can  be 
seen,  attempts  are  made  to  alter  the  motions  so  as  to 
eliminate  the  waste.  These  attempts  sometimes  mean 
changes  in  the  handling  of  tools  by  the  workman,  some- 
times changes  in  the  design  of  the  machine.  Occasion- 
ally additional  new  machinery  is  suggested. 

When  the  final  motions  are  arrived  at,  perfected 
after  many  discussions,  each  of  the  workmen  is  trained 


THE   ORGANIZATION   OF   PRODUCTION          105 

in  the  perfected  methods.  The  materials  are  routed 
in  the  best  possible  manner,  and  the  workmen  are 
stimulated  by  the  offer  of  higher  rates  of  pay. 

There  can  be  no  doubt  whatever  that  scientific 
management,  properly  carried  out,  results  in  a  very 
great  improvement  in  efficiency.  In  actual  experience 
it  has  been  shown  that  efficiency  of  average  workmen 
can  be  increased  as  much  as  three  or  four  hundred  per 
cent.  It  must  be  admitted,  however,  that  there  is  a 
tendency  occasionally  to  consider  the  workman  too 
much  in  the  light  of  a  machine.  This  is  due  rather  to 
a  wrong  interpretation  of  the  system  than  to  the  idea 
of  scientific  management  itself. 

A  careful  use  of  the  knowledge  of  the  dangers  of 
fatigue  and  of  the  importance  of  rest  •  and  change, 
gained  from  the  experiments  of  the  psychologists,  re- 
moves much  of  these  dangers.  The  danger  of  under- 
payment, one  of  the  commonest  causes  of  inefficient 
work,  can  also  be  removed  by  a  sound  application  of 
the  principles  of  scientific  management.  The  key  to 
the  system  is  to  be  found  in  the  scientific  observation 
of  method  with  a  view  to  eliminating  all  waste  effort 
and  the  scientific  application  of  psychological  knowl- 
edge to  the  conditions  necessary  for  the  best  production. 
This  latter  point  includes  the  consideration  of  the 
stimulus  to  effort  due  to  good  working  conditions  and 
the  contentment  resulting  from  just  compensation  for 
work  done. 


CHAPTER  IX 
THE   ORGANIZATION   OF  CAPITAL 

In  an  earlier  chapter  it  was  stated  that  the  present 
system  of  economic  organization  was  one  of  modified 
competition.  The  question  now  to  be  considered  is 
the  means  whereby  competition  between  the  owners 
of  capital  has  been  eliminated.  The  whole  basis  of 
the  organization  of  capital  consists  in  the  attempt  on 
the  one  hand  to  eliminate  competition  and  on  the  other 
to  make  that  competition  which  remains  as  efficient 
as  possible. 

Failure  of  Competition  —  It  is  now  generally  ad- 
mitted that,  as  a  method  of  production,  competition 
is  wasteful.  When  each  owner  of  a  small  amount  of 
capital  puts  that  capital  to  work  in  an  industry  con- 
trolled by  himself,  the  industrial  units  are  necessa- 
rily small.  Hence  all  the  disadvantages  of  small-scale 
production  are  present.  In  distributing  the  product, 
too,  there  are  grave  disadvantages.  When  too  many 
are  competing,  the  tendency  is  to  cut  prices  to  so  low 
a  level  that  none  gets  a  reasonable  return  on  his  ex- 
penditure of  capital  and  labor. 

Limitation  of  Competition,  i.  The  Corporation  — 
The  competitive  system  had  not  been  developed  to  a 
great  extent  before  it  was  realized  that  unlimited  com- 
petition meant  small  profits.  The  establishment  of 
the  corporation  form  of  business,  under  the  principle 
106 


THE   ORGANIZATION   OF  CAPITAL  107 

of  limited  liability,  was  in  itself  a  curtailment  of  com- 
petition. It  meant  the  combination  of  a  great  number 
of  comparatively  small  capital  sums  which,  working 
independently,  would  otherwise  have  produced  a  great 
number  of  small  competing  businesses.  The  unit  of 
production  was  greatly  increased.  But  even  with  this 
increase  in  the  size  of  the  unit,  competition  was  still 
so  keen  that  some  form  of  cooperation  was  bound  in 
time  to  supersede  it. 

2.  Price  Agreements  —  The  great  difficulty  that 
was  felt  was  the  lack  of  control  over  prices.  When 
prices  were  fixed  entirely  by  competition,  the  tendency 
was  to  reduce  them  to  the  lowest  level.  This  was  un- 
satisfactory from  the  point  of  view  of  thetnianufacturer, 
although  it  had  an  undoubted  advantage,  at  least  ap- 
parently, from  that  of  the  consumer  of  the  manufactured 
goods.  Realizing  that  indiscriminate  and  undue  com- 
petition meant  small  profits,  manufacturers  first  agreed 
to  fix  prices  by  mutual  consent.  Such  price  agree- 
ments have  been  very  common  during  the  past  hundred 
years.  They  exist  to-day  in  many  industries,  and  they 
have  undoubtedly  caused  a  rise  in  prices  with  conse- 
quent satisfaction  to  the  manufacturers. 

But  an  agreement  to  maintain  prices  represented 
also  an  agreement  to  control  production.  In  general 
it  may  be  said  that  the  higher  the  price  of  an  article, 
the  smaller  will  be  the  quantity  sold.  If  then,  an  agree- 
ment is  reached  whereby  prices  throughout  a  par- 
ticular industry  are  maintained  at  a  fairly  high  rate, 
following  on  a  period  of  competitively  fixed  low  prices, 
there  will  obviously  occur  a  reduction  in  the  amount 
of  the  goods  actually  sold.  That  means  a  curtail- 


108  AN  INTRODUCTION   TO   ECONOMICS 

ment  of  production.  Now  each  of  the  manufacturers 
who  has  signed  the  agreement  to  maintain  prices  is 
anxious  to  maintain  as  high  a  production  as  possible 
so  as  to  reap  the  full  benefit  of  the  more  profitable 
scale  of  prices.  If  there  is  no  other  method  of  curtail- 
ing competition  than  a  mere  agreement  as  to  selling 
prices,  there  will  inevitably  be  a  tendency  for  some 
member  of  the  associated  group  to  try  a  slight  secret 
cut  in  prices  in  order  to  get  a  larger  share  of  the  sales. 
Hence  there  arises  at  the  very  outset  a  tendency  for 
the  agreement  to  break  down.  For  a  cut  in  prices 
cannot  long  remain  secret,  and  an  agreement  which  is 
not  carried  out  is  worthless. 

Such  an  agreement  has  as  much  actual  value  as 
would  a  law  for  the  breach  of  which  no  penalties  were 
provided.  If  there  were  no  punishment  for  theft,  for 
instance,  there  cannot  be  any  doubt  that  the  crime  of 
theft  would  increase.  This  is  not  an  argument  for  all 
sorts  of  punishments,  of  course,  but  it  is  obviously 
true  that  a  law  is  of  no  value  if  there  are  no  provisions 
for  making  it  effective.  In  regard  to  these  price  agree- 
ments the  necessity  for  some  form  of  compulsion  on 
the  members  of  the  associated  group  has  been  readily 
seen.  In  some  cases  fines  have  been  instituted  by  the 
association  for  any  breach  of  the  agreement.  But 
even  these  fines  are  not  very  satisfactory  unless  there 
is  some  means  whereby  the  payment  of  the  fines  may 
be  enforced.  To  enforce  this  payment  it  has  some- 
times occurred  that  the  members  of  the  group,  upon 
signing  the  agreement,  deposited  with  an  executive 
committee  or  some  outside  body  the  amount  of  the 
fine.  Then  if  any  breach  of  the  agreement  were  proved, 


THE   ORGANIZATION   OF   CAPITAL  109 

the  fine  was  automatically  forfeited  and  became  the 
property  of  the  group  as  a  whole. 

Example  of  Price  Agreement  —  One  of  the  best 
examples  of  a  simple  price  agreement  is  that  of  the 
North  Atlantic  Passenger  Conference.  This  shows  at 
once  the  advantages  and  disadvantages  of  the  system. 
The  Conference  was  formed  for  the  purpose  of  main- 
taining a  uniform  schedule  of  passenger  rates,  par- 
ticularly third-class  rates,  on  the  lines  running  from 
the  European  ports  to  the  United  States.  These  rates 
have  been  maintained  on  the  average  at  something  like 
thirty  to  thirty-five  dollars.  Once  or  twice,  however, 
a  member  has  broken  away  from  the  group,  believing 
that  it  could  obtain  a  greater  proportion  of  the  traffic 
by  a  slight  reduction  of  prices.  There  immediately 
ensued  a  rate  war.  The  other  members  of  the  Con- 
ference at  once  entered  into  fierce  competition  with 
the  recalcitrant  company.  Rates  were  reduced  at 
times  to  as  low  as  twelve  or  fifteen  dollars  for  a  third- 
class  passage.  This  was  considerably  less  than  the 
cost  to  the  companies,  and  obviously,  therefore,  the 
war  could  only  continue  for  a  limited  period  when  a 
new  agreement  was  reached. 

3.  The  Kartel  —  In  order  to  prevent  the  periodical 
recurrence  of  such  rate  wars  a  further  agreement  is 
necessary,  an  agreement  to  divide  the  total  business 
equitably  among  the  producers.  This  form  is  repre- 
sented in  the  German  Kartels.  The  Westphalian 
Coal  Syndicate  is  perhaps  the  best  example  of  this 
sort  of  organization,  although  the  former  Michigan 
Salt  Association  provided  an  American  illustration. 
The  Coal  Syndicate  made  a  careful  estimate  of  the 


110  AN  INTRODUCTION   TO   ECONOMICS 

amount  of  coal  which  could  be  sold  at  a  remunerative 
price  and  then  distributed  the  total  necessary  pro- 
duction among  its  members  in  proportion  to  the  extent 
of  their  productive  powers.  The  selling  of  the  product 
was  carried  out,  not  by  the  individual  members  of  the 
syndicate,  but  by  the  syndicate  as  a  whole  through 
what  were  known  as  Selling  Bureaus. 

The  result  of  this  form  of  organization  has  proved 
very  satisfactory  to  the  producers  in  those  countries 
where  it  still  exists.  In  some  countries,  however,  as 
in  the  United  States,  these  Kartels  are  deemed  to  be 
contrary  to  the  common  law,  under  which  they  are 
considered  to  be  conspiracies  in  restraint  of  trade. 

4.  The  Pool  —  Another  method  which  has  had  nu- 
merous examples  is  what  is  known  as  the  pool.  There 
are  various  forms  of  pool,  however,  of  which  we 
shall  consider  only  the  most  important.  The  principal 
form  was  an  agreement  to  pool  all  orders  and  have 
them  executed  proportionately  to  productive  capacity 
of  the  members  and  to  pool  also  the  prices  obtained 
by  the  sale  of  the  goods. 

All  such  agreements,  however,  have  the  very  grave 
defect  that  they  still  permit  of  the  existence  of  dupli- 
cated effort.  It  is  quite  possible  that  two  or  three 
members  of  the  group  have  facilities  sufficient  to  pro- 
duce all  the  goods  necessary  to  satisfy  the  market,  or 
at  least  to  satisfy  all  the  demand  at  the  price  which  the 
association  deems  remunerative.  The  work  of  all  the 
other  producers,  therefore,  is  more  or  less  wasteful. 
If  there  is  to  be  real  efficiency,  there  must  be  control 
of  both  ends  of  the  business,  the  producing  as  well  as 
the  selling  end.  Although  the  price  agreements  elimi- 


THE   ORGANIZATION   OF   CAPITAL  111 

nate  competition  from  the  selling  department,  com- 
petition among  the  producers  is  still  allowed.  In 
order  that  all  competition  should  be  removed  a  greater 
approximation  to  monopoly  of  both  production  and 
selling  must  be  made. 

5.  Monopolies  —  The  great  tendency  of  modern 
times  is  towards  the  development  of  monopolies.  In 
this  chapter  no  attempt  will  be  made  to  discuss  monopo- 
lies from  the  standpoint  of  the  consumer.  This  must 
be  left  for  future  discussion.  At  present  our  concern 
is  with  the  methods  of  organization  and  the  nature  of 
the  economies  produced. 

Monopolistic  organization  is  only  possible  where 
the  economies  of  large-scale  production  can  be  secured. 
In  those  industries  where  individual  skill  is  necessary 
there  is  little  if  any  tendency  to  monopoly.  There  is, 
for  instance,  no  possibility  of  monopoly  in  the  paint- 
ing of  pictures.  But  there  is  undoubtedly  much 
greater  possibility  in  the  reproduction  of  those  pictures. 
The  original  paintings  require  a  certain  amount  of 
individual  skill  and  insight  into  the  artistic  values. 
The  reproduction  of  the  pictures  involves  the  use  of 
more  or  less  mechanical  processes.  The  reproduction 
of  famous  paintings  on  picture  postal  cards  which  are 
sold  by  the  million  is  a  large-scale  business.  The 
original  paintings  were  the  work  of  great  artists.  The 
same  is  true  of  the  modern  printing  business  as  com- 
pared with  the  medieval  form  of  copying  manuscript. 
The  monks  of  the  middle  ages  made  their  copies  of  the 
writings  of  the  fathers  works  of  art  in  themselves.  The 
modern  printer  makes  thousands  of  duplicates,  in  which 
the  artistic  effort  in  producing  one  is  reproduced  exactly 


112  AN   INTRODUCTION   TO   ECONOMICS 

in  all  of  the  others.  Hence  large-scale  production  is 
necessary,  where  formerly  it  was  impossible. 

There  are  very  many  forms  of  monopolies  successful 
in  a  greater  or  less  degree,  and  known  by  names  which 
are  commonly  used  in  ordinary  speech.  So  common 
are  these  terms,  however,  that  they  are  frequently 
misused.  The  average  person  who  speaks  of  trusts, 
for  example,  seldom  does  so  in  the  accurate  sense.  To 
him  the  word  trust  is  synonymous  with  monopoly. 
Now  it  is  fairly  true  to  say  that,  with  the  exception  of 
those  industries  which  are  definitely  the  care  of  the 
governmental  organization,  such  as  the  post  office, 
there  is  no  true  monopoly  existent.  There  are  organi- 
zations which  approach  monopolies,  however,  and  it  is 
with  these  that  we  must  deal. 

6.  The  Trust  —  The  most  familiar  term  is  the  Trust. 
The  word  was  first  used  in  connection  with  a  particular 
form  of  organization  arising  out  of  the  growth  of  the 
Standard  Oil  Company.  In  this  case  a  number  of 
competing  corporations  were  grouped  together,  and 
the  stock  of  the  individual  corporations  was  assigned 
to  a  group  of  Trustees  in  return  for  Trust  Certificates. 
The  whole  of  the  organization  of  the  united  corporations 
was  left  in  the  hands  of  the  Board  of  Trustees  and 
dividends  were  paid  on  the  trust  certificates  and  not 
on  the  original  stock.  This  form  of  organization  was 
not  objected  to  merely  on  account  of  the  form,  but 
rather  on  account  of  the  monopoly  which  was  thereby 
attempted.  The  form  was  attacked  under  common 
law  on  the  ground  that  it  was  a  conspiracy  in  restraint 
of  trade,  and  so  was  no  longer  permissible.  But  al- 
though the  trust  form  has  disappeared,  the  institu- 


THE   ORGANIZATION   OF   CAPITAL  113 

tions  which  were  combined  under  that  form  still  re- 
main. The  form  is  changed,  but  the  fact  remains  the 
same.  The  principal  form  under  which  what  were 
formerly  trusts  and  what  are  now  often  called  trusts 
are  organized,  is  more  accurately  known  as  the  holding 
corporation. 

7.  TJie  Holding  Company  —  It  will  readily  be  under- 
stood that  the  control  of  a  corporation  rests  in  the 
hands  of  the  stockholder  or  group  of  stockholders  who 
control  a  majority  of  the  stock.  As  a  rule  each  share 
of  stock  carries  one  vote.  If  five  men  club  together 
to  buy  a  share  of  stock  for  a  thousand  dollars,  they 
have  between  them  the  right  to  one  vote  at  the  stock- 
holders' meetings.  If  one  man  owns  a  hundred  of 
such  shares,  he  has  one  hundred  votes.  In  any  case, 
then,  the  man  or  group  who  owns  fifty -one  per  cent  of 
the  stock  is  able  to  outvote  all  the  other  stockholders. 
They  have  no  more  say  in  the  management  of  the 
business  than  if  they  had  no  stock  at  all.  Indeed  it 
is  not  really  necessary  in  most  cases  for  the  individuals 
to  possess  the  whole  of  the  fifty-one  per  cent.  All  they 
need  to  secure  absolute  control  is  to  secure  that  amount 
of  voting  power.  A  compact  group  or  single  indi- 
vidual who  owns  let  us  say,  forty  per  cent  of  the  stock 
of  a  company,  has  usually  the  power  of  deciding  who 
is  the  president  of  that  company  and  the  board  of 
Directors,  unless  the  remaining  stock  is  held  by  an- 
other individual  group.  If  it  happens  that  the  rest 
of  the  stock  is  held  by  a  great  number  of  small  holders, 
then  his  power  is  practically  supreme.  For  the  great 
majority  of  the  stockholders  will  not  vote  personally 
at  the  general  meetings.  They  will  send  their 


114  AN  INTRODUCTION   TO   ECONOMICS 

"  proxies  "  as  a  rule  to  the  President  of  the  Corpo- 
ration. The  group  or  individual  who  controls  the 
appointment  of  the  president,  therefore,  controls 
also  the  voting  of  the  proxies,  as  well  as  of  his  own 
shares. 

It  is  obvious,  therefore,  that  in  order  to  decide  the 
policies  and  methods  of  operation  of  a  company,  all 
that  is  necessary  is  to  gain  control  of  fifty-one  per  cent 
of  the  voting  power  in  that  corporation.  Now  sup- 
pose a  group  of  men  wish  to  control  several  corpora- 
tions. They  may  pool  their  capital  and  with  the  total 
obtain  control  of  each  of  the  companies.  Their  "  pool  " 
may  be  organized  under  the  corporation  laws  as  a 
"  corporation  formed  for  the  purpose  of  holding  stock 
in  "  such  and  such  companies.  This  new  corporation 
does  not  need  to  possess  all  the  capital  of  the  indi- 
vidual companies  which  it  desires  to  control.  At  most 
all  that  is  required  is  the  fifty-one  per  cent  of  stock, 
and  even  this  amount,  if  the  work  of  the  holding  corpo- 
ration is  skillfully  carried  out,  need  not  be  necessary. 
Essentially  there  is  no  difference  between  this  form  of 
monopolistic  organization  and  the  older  form  of  the 
trust,  except,  possibly,  that  the  new  form  gives  the 
same  results  with  a  little  more  economy  of  capital. 

The  holding-corporation  form  makes  possible  the 
control  of  a  great  industry  by  a  small  group  who,  of 
themselves,  possess  only  a  comparatively  small  pro- 
portion of  the  capital  necessary  to  conduct  the  in- 
dustry. Figure  2  will  help  to  illustrate  this  possi- 
bility. The  four  squares,  A,  B,  C,  D,  represent,  let 
us  say,  four  boot-and-shoe-making  corporations,  each 
capitalized  at  one  hundred  thousand  dollars. 


THE   ORGANIZATION   OF   CAPITAL 


115 


The  Holding  Corporation  holds  fifty-one  per  cent  of 
the  stock  in  each  of  the  companies.  Its  total  capitali- 
zation consists  merely  in  the  amount  of  stock  of  the 


$100.000 


#/00,000 


other  companies  which  it  holds,  and  this  amounts  to 
two  hundred  and  four  thousand  dollars.  With  this 
sum  it  is  able  to  control  a  capital  of  four  hundred 
thousand  dollars.  But  this  is  not  all.  The  stock  in 


116  AN  INTRODUCTION   TO   ECONOMICS 

the  holding  corporation  may  have  been  put  on  the 
market,  with  the  exception  of  fifty-one  per  cent  neces- 
sary to  reserve  control  for  the  principal  stockholders. 
These  latter,  therefore,  with  a  capital  of  a  hundred  and 
three  thousand  dollars  are  able  to  control  entirely  the 
corporation's  two  hundred  and  four  thousand  dollars, 
and  thus  in  turn  control  the  working  of  the  four  boot- 
making  companies. 

This  is  the  form  in  which  most  of  the  modern 
"trusts"  are  organized,  and  a  recent  enumeration 
gives  a  list  of  some  two  hundred  and  thirty  such 
organizations. 

Another  form  is  the  merger.  This  is  merely  the 
absorption  of  one  organization  by  another,  or  the  com- 
bination of  two  or  more  corporations  into  one. 

Uniform  Object  to  Eliminate  Competition  —  What- 
ever be  the  form,  however,  the  aim  is  the  same  in  all 
cases.  It  is  to  eliminate  competition  to  as  great  an 
extent  as  possible.  Actual  monopoly,  as  has  already 
been  said,  has  not  been  attained.  But  actual  monopoly 
is  not  necessary  for  the  purpose  of  controlling  prices. 
If  the  competing  companies  are  only  able  to  supply  a 
small  portion  of  the  total  production,  it  is  likely  that 
they  will,  without  any  formal  agreement,  charge  a 
price  which  is  approximately  equal  to  that  charged 
by  the  "  trust."  If  they  make  an  unduly  strong  at- 
tempt to  beat  the  monopoly's  price,  they  will  subject 
themselves  to  very  severe  competition,  which  may 
easily  ruin  them. 

Effects  of  Monopoly  Organization  —  It  is  not  an  easy 
task  to  estimate  the  effects  of  such  quasi-monopolistic 
organizations.  As  far  as  the  securing  of  large-scale 


THE    ORGANIZATION   OF   CAPITAL  117 

production  economies  is  concerned,  it  is  probably  true 
that  the  monopolistic  form  is  economical,  but  it  is  not 
necessarily  so.  There  may  still  be  a  great  deal  of 
waste,  and  if  the  monopoly  is  very  powerful,  it  may 
lack  the  stimulus  necessary  to  force  it  to  secure  all  the 
possible  economies  which  production  on  a  large  scale 
should  entail. 

Again,  it  is  quite  true  that  monopoly  organizations 
may  find  it  more  profitable  to  sell  a  comparatively 
small  amount  of  goods  at  a  large  unit  price  than  to 
sell  great  quantities  at  a  smaller  figure.  This  question 
of  monopoly  price,  however,  is  one  which  will  come  up 
for  consideration  in  a  future  chapter. 

Improvements  in  production  are  not  always  in- 
troduced readily  in  a  monopoly.  This  is  one  of  the 
criticisms  aimed  at  government  operation  of  businesses. 
Improvements  in  manufacturing  methods  often  entail 
very  heavy  expenditures  for  new  machinery  while  the 
old  may  not  be  nearly  worn  out.  It  has  been  charged 
against  several  big  combinations  that  they  have  bought 
up  patent  rights  to  new  inventions  with  the  definite 
idea  of  preventing  the  new  inventions  being  used. 

On  the  reverse  side,  it  may  be  said  that  considerable 
overlapping  of  production  may  be  avoided  under  a 
monopoly  organization.  Unnecessary  competitive  ad- 
vertising may  be  saved.  It  is  often  urged,  also,  that 
benefits  to  the  consumer  result  from  lower  prices 
charged  by  monopolies.  It  is  true,  indeed,  that  some 
monopoly  commodities,  as,  for  example,  illuminating 
oil,  have  become  cheaper  under  partial  monopolies 
than  they  were  formerly  under  free  competition.  But 
that  does  not  mean  that  the  prices  charged  are  as  low 


118  AN  INTRODUCTION   TO   ECONOMICS 

as  they  ought  to  be.  It  may  be  that  had  free  com- 
petition still  obtained,  together  with  more  modern 
methods  of  production,  the  price  would  be  still  lower. 

Control  of  Monopolies  —  The  question  of  the  con- 
trol of  corporations  which  approach  the  monopoly 
form  is  one  which  is  exciting  a  great  deal  of  public 
interest.  This  is  naturally  so,  for  the  public  is  quite 
right  in  being  anxious  not  to  let  the  important  serv- 
ices and  commodities  of  life  drift  into  the  hands  of  a 
small  group  whose  only  interest  is  to  make  the  highest 
amount  of  profit.  The  arguments  usually  alternate 
from  the  advocacy  of  government  control  to  that  of 
government  ownership.  Without  at  present  discussing 
the  arguments  in  detail,  it  may  be  said  that  there  is 
considerable  justification  for  each  point  of  view.  It 
is  doubtful  at  present  whether  the  governmental  forces 
are  sufficiently  well  organized  to  take  charge  of  the 
operations  of  great  manufacturing  industries.  But 
these  organizations  must  be  subject  to  some  form  of 
control.  They  must  not  be  allowed  to  levy  tribute 
upon  the  general  population.  Control,  however,  is 
a  word  with  only  relative  force.  Some  government 
interference  is,  if  not  exactly  welcomed  by  the  monopo- 
lies, at  least  easily  tolerated.  The  tendency,  however, 
is  towards  the  increase  of  control  to  the  point  where 
the  distinction  between  control  and  ownership  almost 
ceases. 

Justification  of  Monopolies  —  Whether  it  be  owner- 
ship or  control,  however,  there  can  only  be  one  justi- 
fication for  the  existence  of  monopolies.  That  is,  they 
must  be  able  to  work  with  economies  impossible  under 
a  system  of  modified  or  free  competition.  They  must 


THE   ORGANIZATION   OF   CAPITAL  119 

actually  eliminate  waste  in  production.  Prices  must 
not  be  based  on  the  idea  of  securing  the  largest  profit, 
but  rather  with  a  view  of  securing  the  widest  sale  at 
a  price  which  provides  the  normal  return  for  capital 
and  labor. 

Further  the  capitalistic  organization  must  be  such 
as  to  protect  the  small  stockholder  as  well  as  the  large. 
Under  the  holding-corporation  system,  the  small  stock- 
holder stands  little  chance  of  protecting  his  interests. 
Theoretically  he  has  a  vote,  but  a  theoretical  vote  is 
of  little  importance  when  it  is  always  overthrown  in 
practice. 

A  further  point  arises  in  connection  with  the  per- 
mission of  competing  organizations  in  businesses  which 
are  of  the  nature  of  monopolies.  Most  public  utili- 
ties are  best  operated  as  monopolies,  whether  publicly 
owned  or  not.  Competing  street  car  and  lighting 
systems,  or  telephone  systems  are  undoubtedly  un- 
desirable. Past  experience  in  many  cities  has  proved 
this  beyond  a  doubt.  At  the  time  of  writing,  the  crisis 
of  a  world  war  has  brought  into  prominence  the  evil 
effects  of  competing  railroad  systems  throughout  a 
country.  Practically  all  public  utilities  ought  to  be 
conducted  as  monopolies.  This  is  usually  admitted, 
but  the  points  of  dispute  arise  from  questions  of  owner- 
ship and  control.  Some  discussion  of  these  questions 
will  be  given  later  after  the  student  is  more  familiar 
with  the  problems  of  exchange  and  of  labor. 


CHAPTER  X 

VALUE 

Meaning  of  the  Term  Value  —  We  have  already  seen 
that  there  are  many  meanings  which  can  be  under- 
stood from  terms  used  in  our  study  of  economics. 
Dealing,  as  it  does,  with  matters  which  affect  our  daily 
lives,  economics  is  bound  to  borrow  its  terms  from 
common  language.  But  common  colloquial  language 
is  seldom  definite.  We  realize  when  talking  in  ordinary 
conversation  what  is  meant  by  the  speakers  rather 
than  what  is  meant  by  the  particular  words.  The 
word  value,  for  instance,  has  many  meanings.  When 
we  ask  what  is  the  value  of  a  certain  piece  of  land,  we 
may  mean  how  may  it  be  used  ;  but  we  may  also  mean 
how  many  dollars  are  necessary  to  purchase  it.  We 
speak  of  the  value  of  the  right  to  freedom  of  thought, 
the  value  of  fresh  air,  the  value  of  good  health,  the  value 
of  a  loaf  of  bread  or  of  a  piano,  and  so  forth.  In  speak- 
ing to  a  doctor,  for  example,  we  ask  what  is  the  value 
of  bread  and  he  will  answer  in  terms  of  the  usefulness 
of  bread  as  food.  But  when  we  ask  the  same  question 
of  the  baker,  he  will  tell  us  how  many  cents  a  loaf  costs. 

If  we  are  to  use  the  term  with  any  degree  of  accuracy, 

it  is  necessary  for  us  to  give  it  a  definition  which  will 

limit  the  meaning  of   the  word   value  in  such  a  way 

that  we  shall  always  understand  the  same  idea  when 

120 


VALUE  121 

we  hear  the  word.  It  does  not  follow  that  the  mean- 
ings which  must  be  excluded  are  necessarily  wrong. 
Obviously  this  is  not  the  case.  But  from  our  point 
of  view  there  are  certain  aspects  which  do  not  affect 
us.  In  economics  we  are  endeavoring  to  measure 
motives  and  laws.  We  wish  to  deal  with  concrete 
matters  as  much  as  possible.  Hence  what  we  may 
here  term  the  ethical  meanings  of  words  are  not  con- 
sidered. 

In  economics,  the  word  value  signifies  a  ratio.  It 
means  the  ratio  in  which  one  article  exchanges  for  an- 
other. If  it  is  found  that  a  pound  of  coffee  exchanges 
readily  for  half  a  pound  of  butter,  we  say  that  the  value 
of  a  pound  of  coffee  is  equal  to  that  of  half  a  pound  of 
butter.  That  is,  we  refer  to  value  as  value  in  exchange. 
This  is  the  only  sense  in  which  we  shall  use  the  term 
in  our  future  discussions.  The  purpose  of  the  chapters 
which  follow  is  to  consider  how  value  is  determined 
and  how  the  process  of  exchange  is  carried  on.  That 
is,  we  must  study  the  reasons  which  cause  variations 
in  the  ratio  of  exchange  of  one  commodity  for  another 
and  the  mechanism  by  which  such  exchanges  are  made. 

In  Chapter  IV  it  was  shown  that  all  production  was 
production  of  utilities,  and  so  likewise  was  all  consump- 
tion. In  exchange  it  is  exchange  of  commodities  and 
services  with  which  we  deal.  The  exchange  will  de- 
pend very  largely  upon  the  utilities  of  the  commodities 
and  services.  Utility  was  defined  as  the  power  to 
satisfy  wants  or  desires.  A  piece  of  steel  shaped  so 
that  it  will  cut  wood  or  metal  possesses  utility  only 
because  there  is  a  desire  for  such  an  article.  The  serv- 
ices of  a  doctor  or  lawyer  possess  utility  because  there 


122  AN  INTRODUCTION   TO   ECONOMICS 

is  a  desire  to  consume  those  services.  A  bottle  of 
whisky  possesses  utility  because  there  is  a  desire  to 
consume  that  whisky. 

Diminishing  Utility  —  There  are,  however,  variations 
in  the  intensity  with  which  these  commodities  and 
services  are  desired.  For  example,  it  we  are  very 
thirsty,  our  demand  for  some  thirst-quenching  liquid 
is  very  strong,  but  when  we  have  satisfied  our  thirst 
the  desire  is  much  weaker.  With  each  additional 
drink  our  desire  for  more  water  is  reduced.  In  other 
words,  the  utility  of  the  glass  of  water  diminishes  with 
each  additional  glass.  No  estimate  of  the  value  of 
the  first  glass  can  be  made  if  a  person  is  on  the  verge 
of  death  from  thirst.  In  a  desert  where  water  is  of 
paramount  importance,  the  prospector  would  some- 
times give  his  last  ounce  of  gold  dust  for  a  single  drink. 
But  let  him  believe  that  he  can  reach  the  next  water- 
hole  without  a  further  drink,  his  desire  is  reduced  con- 
siderably. When  he  has  actually  reached  the  water 
supply,  then  he  will  exchange  nothing  for  the  drink. 
His  wants  being  satisfied,  there  is  no  further  utility 
in  the  water. 

Let  us  take  a  further  illustration.  Most  of  us  have 
a  desire  at  times  for  coffee.  The  desire  has  not  the 
same  intensity  for  each  of  us,  however.  In  an  in- 
dividual case  a  man  may  so  desire  coffee  that  he  is 
willing  to  pay,  let  us  say,  ten  dollars  for  a  pound  of 
coffee.  At  that  price,  however,  he  will  content  him- 
self with  one  pound.  If  the  price  be  reduced  to  eight 
dollars  a  pound,  he  may  buy  another  pound.  In  this 
case  it  would  seem,  therefore,  that  the  utility  of  the 
first  pound  of  coffee  is  represented  by  ten  dollars,  but 


VALUE  123 

that  of  the  second  is  only  eight  dollars.  If  the  price 
be  reduced  to  six  dollars,  then  he  will  buy  another 
pound,  showing  that  the  utility  of  the  third  pound  is 
six  dollars.  And  so  the  utility  of  each  additional 
pound  of  coffee  falls  until  a  point  is  reached,  let  us  say, 
at  thirty  cents  a  pound  when  he  will  buy  no  more  coffee, 
no  matter  how  much  further  the  price  be  reduced.  His 
wants  are  all  satisfied  in  respect  to  coffee  when  the 
price  falls  to  thirty  cents. 

This  gradual  fall  in  the  utility  of  a  given  commodity  is 
spoken  of  as  the  law  of  diminishing  utility,  and  it  may 
be  expressed  as  follows.  The  utilities  of  additional 
units  of  any  commodity  to  any  consumer  tend  to  fall 
as  his  supply  of  that  commodity  increases. 

As  we  have  seen,  however,  the  element  of  price  enters 
into  the  question.  In  our  last  illustration  the  utility  of 
a  single  pound  of  coffee  was  represented  by  ten  dollars. 
If  we  tabulate  the  particulars,  we  shall  have  a  state- 
ment something  like  this : 

PBICE        QUANTITY  CONSUMED  PRICE  QUANTITY  CONSUMED 

$10  1  pound  $3  6  pounds 

8  2  pounds  2  7  pounds 

6  3  pounds  1  8  pounds 

5  4  pounds  .50  9  pounds 

4  5  pounds  .30  10  pounds 

Marginal  Utility  —  If  the  price  had  gone  above  ten 
dollars  a  pound,  no  coffee  would  have  been  bought 
by  this  particular  consumer.  But  he  was  willing  to 
pay  as  high  as  ten  dollars  for  one  pound.  The  dividing 
line  between  one  pound  of  coffee  and  none  at  all  is 
represented  by  the  price  of  ten  dollars.  This  dividing 


124  AN  INTRODUCTION   TO   ECONOMICS 

line  is  called  the  margin.  The  marginal  utility  of  one 
pound  of  coffee  is  ten  dollars.  The  marginal  utility 
of  the  second  pound  is  eight  dollars ;  of  the  fifth  pound 
four  dollars,  and  so  on. 

When  the  price  of  coffee  has  fallen  to,  let  us  say,  two 
dollars  a  pound,  the  individual  under  consideration 
will  buy  eight  pounds.  Rather  than  buy  any  more 
coffee  at  that  price  he  will  spend  his  money  on  some 
other  commodity  which,  he  thinks,  will  yield  him  more 
satisfaction.  The  question  which  he  will  put  to  him- 
self, unconsciously,  perhaps,  is  this :  "  Will  there,  be 
more  satisfaction  out  of  an  additional  pound  of  coffee 
if  I  spend  another  two  dollars  than  if  I  spend  that 
additional  two  dollars  on  tea  or  tobacco  ?  "  If  he 
decides  not  to  expend  another  two  dollars  on  coffee, 
then  it  is  plain  that  the  marginal  utility  of  coffee  is 
reached  at  eight  pounds.  It  is  true  that  he  would  gain 
additional  satisfaction  from  more  coffee,  but  the  ad- 
ditional satisfaction  would  require  an  expenditure  of 
another  two  dollars  and  he  believes  that  he  could  get 
more  satisfaction  from  spending  the  two  dollars  on 
something  else. 

Present  and  Future  Satisfaction  —  There  is  another 
aspect  of  the  question,  however,  besides  that  of  the 
marginal  utility  of  two  different  commodities.  The 
marginal  utility  of  one  commodity  at  different  times 
will  vary.  If  the  question  is  one  of  immediate  satis- 
faction, it  is  not  the  same  as  if  the  satisfaction  is  to  be 
postponed  to  the  future.  Suppose  a  man  wishes  to 
buy  a  box  of  cigars  and  the  price  is  ten  dollars.  He 
wants  that  box  immediately.  If  he  is  told  that  he 
cannot  get  the  cigars  until  next  week,  he  may  think 


VALUE  125 

that  it  is  better  worth  while  to  spend  the  money  on 
some  present  satisfaction  unless,  perhaps,  the  tobacco- 
nist offers  to  let  him  have  the  cigars  next  week  at  eight 
dollars.  In  that  case  he  may  decide  to  save  eight 
dollars  for  the  cigars  and  spend  the  two  on  immediate 
satisfaction.  From  which  it  is  clear  that  the  marginal 
utility  of  a  box  of  cigars  to  be  had  immediately  is 
greater  than  that  of  a  similar  box  for  which  the  pur- 
chaser has  to  wait. 

In  making  a  decision  to  purchase  anything  the  ques- 
tion which  has  to  be  decided  is  one  of  relative  marginal 
utility.  If  the  individual  above  referred  to  is  in  doubt 
whether  to  buy  a  few  cigars  or  to  go  to  the  theater, 
the  marginal  utility  of  the  one  satisfaction  is  almost 
equal  to  that  of  the  other  and  his  choice  decides  which 
has  the  greater.  Of  course,  the  decision  is  not  the  re- 
sult of  careful  thought  each  time.  The  mere  fact  that 
a  decision  is  made  shows  that  to  that  man  at  that  par- 
ticular time  the  marginal  utility  of  the  one  satisfaction 
which  he  chooses  is  greater  than  that  of  the  one  he 
rejects. 

The  ratio  between  future  and  present  satisfactions 
varies  greatly  with  peoples  and  with  individuals. 
Children  and  savages  place  a  very  much  higher  value 
upon  present  satisfactions  than  upon  future.  Races 
of  higher  culture  and  individuals  of  greater  intelligence 
make  less  difference  between  the  two. 

As  value  is  merely  a  ratio  of  exchange,  in  order  to 
know  the  value  of  any  article  we  have  to  discover  for 
what  other  article  it  will  exchange.  An  article  cannot 
be  said  to  have  value,  in  the  economic  sense,  of  itself. 
There  is  no  such  phrase  as  intrinsic  value  in  economics. 


126  AN  INTRODUCTION   TO   ECONOMICS 

Consequently  in  any  exchange  the  values  of  the  ex- 
changed articles  are  equal  to  one  another.  If  a  man 
exchanges  a  city  lot  for  an  automobile,  he  feels  that  he 
is  getting  something  which  he  desires  in  place  of  some- 
thing which  he  desires  somewhat  less.  The  other 
party  to  the  transaction  has  a  similar  feeling.  The 
difference  is  not  a  difference  in  values,  but  a  difference 
in  satisfactions.  The  owner  of  the  lot  would  not  give 
his  lot  for  the  automobile  unless  he  felt  that  he  could 
obtain  more  satisfaction  from  the  machine.  And  like- 
wise the  owner  of  the  automobile  thinks  that  the  lot 
will  give  him  more  satisfaction  than  he  obtained  from 
his  car.  Both  parties  are,  therefore,  satisfied. 

This  refers,  however,  to  individual  transactions,  and 
it  is  not  with  these  instances  that  we  are  concerned. 
What  we  desire  to  find  out  are  the  laws  which  govern 
all  exchanges,  if  there  be  any  such.  We  have  already 
seen  in  an  earlier  chapter  that  utilities  are  only  pro- 
duced to  satisfy  desires  which  are  either  existent  or 
latent;  that  is,  desires  which  are  already  well  known 
and  others  which  are  not  known  to  exist,  but  are  wait- 
ing the  utility  which  will  satisfy  them  and  thus  call 
them  into  being.  We  know,  moreover,  that  in  our 
present  organization  each  one  of  us  is  a  specialist  of 
some  sort.  None  of  us  produces  for  himself  all  that 
he  requires.  There  must,  therefore,  be  some  means  of 
securing  the  correct  distribution,  or,  at  least,  the  ap- 
proximately correct  distribution  of  the  productive 
effort  in  order  that  our  desires  may  be  met  as  well  as 
they  are. 

Effective  Demand  —  It  is  true  that  many  of  our 
desires  are  not  met.  The  absolutely  contented  man 


VALUE  127 

does  not  exist,  and  if  he  did,  it  is  doubtful  whether  he 
would  be  of  any  great  service  to  humanity.  Civiliza- 
tion does  not  grow  with  a  diminution  in  the  number  of 
wants,  but  by  their  increase.  But  every  want  does 
not  bring  forth  the  necessary  production.  Something 
more  is  required  than  mere  desire.  There  must  be 
something  produced  to  exchange  for  the  new  produc- 
tion which  is  to  satisfy  the  want.  For  example,  the  un- 
skilled laborer  may  desire  with  all  his  heart  to  possess 
a  limousine.  But  that  desire  will  not  bring  about  the 
production  of  limousines.  For  in  order  that  the  laborer 
may  obtain  one  he  must  be  able  to  exchange  something 
for  it,  and  it  is  only  a  remote  possibility  that  he  possesses 
any  article  which  the  limousine  producer  is  willing  to 
accept  in  exchange.  The  demand  exists,  but  it  is  not 
an  effective  demand.  In  order  to  become  effective  the 
producer  of  the  limousine  must  be  willing  to  accept 
something  in  exchange  which  the  laborer  is  able  to 
offer.  When  we  say,  therefore,  that  demand  produces 
the  supply,  or,  to  be  more  accurate,  that  demand  causes 
the  supply  to  be  produced,  we  must  qualify  the  word 
demand  by  considering  only  the  effective  demand. 
And  there  must  be  a  similar  qualification  in  regard  to 
supply.  A  supply  of  a  commodity  may  exist,  but  it 
may  not  be  available.  The  iron  ore  in  the  Andes  un- 
questionably exists,  but  it  is  not  an  element  in  the 
supply  of  iron  because  it  is  not  worked. 

Meaning  of  Price  —  Again,  when  it  is  said  that  the 
ratio  at  which  any  commodity  exchanges  for  another 
depends  upon  the  demand  for  and  the  supply  of  the 
commodities,  the  same  restriction  in  the  meaning  of 
the  two  terms  must  be  made.  In  order  to  make  our 


128  AN  INTRODUCTION   TO   ECONOMICS 

discussion  a  little  more  simple  we  shall  speak  of  ex- 
changes of  commodities  for  money.  This,  as  we  shall 
see  later  on,  is  merely  an  intermediate  form  of  exchang- 
ing goods  for  goods.  But  for  the  present  purpose  the 
ordinary  meaning  of  the  word  price  will  be  satisfactory. 
Stated  simply,  price  is  the  ratio  at  which  a  commodity 
or  article  or  service  exchanges  for  money.  To  repeat 
the  statement  made  at  the  beginning  of  this  paragraph 
in  another  form  we  may  say  that  price  is  governed 
by  supply  and  demand.  This  statement  is  accepted 
commonly,  but  it  is  very  frequently  misused  and  we 
must  be  careful  to  understand  all  the  assumptions  that 
are  made  when  the  phrase  is  correctly  used. 

Let  us  take  the  case  of  the  price  of  coal  for  the  sake  of 
illustration,  and  consider  it  first  from  the  point  of  view 
of  the  demand.  Coal  is  used  for  many  purposes,  — 
fuel  for  household  fires,  for  steam  engines,  for  gas  pro- 
duction, for  coke  making,  and  so  forth.  The  general 
demand  is  very  great.  But  the  intensity  of  the  demand 
of  the  various  groups  who  desire  coal  varies  within 
wide  limits.  There  are  some  who  must  have  coal  at 
all  costs,  or  cease  their  own  production ;  as,  for  example, 
steamship  owners,  and  gas  companies.  There  are 
others  who  will  not  have  coal  unless  they  can  get  it 
at  a  very  low  price.  Between  the  two  extremes  there 
are  many  grades.  These  grades  can  best  be  dis- 
tinguished by  the  prices  they  are  willing  to  pay  for  the 
coal.  If  coal  should  be  sold  only  at  a  price  of  eighty 
dollars  a  ton,  a  great  many  would-be  coal  users  must 
refuse  to  purchase.  At  that  price  their  demand  is  not 
effective.  Some  there  will  be  who  must  have  coal  and 
who  can  afford  to  pay  that  price.  These  constitute 


VALUE  129 

only  a  small  portion  of  the  total  possible  purchasers. 
Now,  if  the  price  be  reduced  to  forty  dollars  a  ton, 
there  will  be  an  additional  group  who  will  now  buy 
coal.  The  reduction  in  price  has  made  effective  an 
additional  demand.  Let  the  price  fall  now  to  twenty- 
five  dollars  a  ton  and  the  effective  demand  will  be  very 
greatly  increased.  When  the  price  is  reduced  to  five 
dollars  a  ton,  there  is  an  immense  increase  in  the  ef- 
fective demand. 

Relations  between  Supply  and  Demand,  and  Price  — 
Now  turn  to  the  question  of  the  supply.  When  the 
price  is  as  high  as  fifty  dollars  a  ton,  almost  every  avail- 
able ton  of  coal  will  be  offered  for  sale.  The  physical 
supply  becomes  almost  the  same  thing  as  the  effective 
supply.  But  as  the  price  falls,  some  of  those  who  have 
a  supply  of  coal  will  refuse  to  sell.  The  lower  the 
price,  the  smaller  will  be  the  effective  supply,  until, 
when  the  price  has  reached  the  point  at  which  the  de- 
mand is  greatest,  the  supply  is  at  its  lowest  limit.  We 
may  say  then,  that,  as  a  rule,  the  lower  the  price  the 
greater  the  demand  and  the  smaller  the  supply. 

In  the  case  of  commodities  which  are  actual  physical 
necessities  differences  in  price  will  not  affect  the  amount 
demanded  except  to  the  extent  that  possibly  some  of 
those  whose  demand  is  not  effective  will  die  and  so  re- 
duce the  possible  demand. 

Elasticity  of  Demand  —  The  difference  which  a  rise 
or  fall  in  price  will  make  to  the  effective  demand  will 
vary  according  to  the  nature  of  the  commodity.  The 
more  nearly  the  commodity  approaches  to  a  physical 
necessity  the  less  difference  will  an  alteration  in  price 
effect.  We  may  speak  of  the  possible  variations  in 


130  AN  INTRODUCTION   TO   ECONOMICS 

demand  due  to  a  change  in  price  as  the  elasticity  of 
demand.  When  a  fall  in  price  causes  a  large  increase 
in  the  effective  demand,  the  demand  is  said  to  be  elastic. 
When  there  is  little  difference  caused,  the  demand  is 
inelastic.  As  a  rule  we  see  the  greatest  elasticity  of 
demand  in  those  articles  which  are  luxuries.  This  is 
naturally  so.  All  of  us  desire  the  luxuries  as  well  as  the 
necessities  of  life.  We  must  first  satisfy  ourselves  in 
regard  to  necessities,  but  after  that  we  seek  the  luxuries. 
The  reason  we  do  not  all  succeed  in  obtaining  as  large 
a  share  of  the  luxuries  in  life  is  that  our  demand  is  not 
effective.  The  price  is  a  little  above  what  most  of  us 
can  afford  to  pay.  But  a  drop  in  prices  will  make 
immediately  effective  a  great  deal  of  latent  demand. 

There  are  other  causes,  however,  which  affect  the 
elasticity  of  demand.  There  are  hardly  any  articles 
or  goods  which  can  be  considered  in  themselves  to  be 
absolute  physical  necessities.  Food  is  a  necessity,  of 
course,  but  food  is  a  word  which  includes  in  its  mean- 
ing many  articles,  none  of  which  is  by  itself  essential. 
For  instance,  we  may  say  that  wheat  is  a  necessity.  In 
so  far  as  it  is  a  source  of  food  we  may  safely  so  regard  it. 
But  if  the  supply  of  wheat  is  only  effective  at  a  high 
price,  the  demand  will  fall  off  very  largely.  This  is  be- 
cause there  are  other  forms  of  food  which  will  satisfy 
our  needs  as  well  or  almost  as  well  as  wheat.  Con- 
sequently a  high  price  in  wheat  may  cause  a  very  great 
fall  in  the  demand,,  as  the  demand  for  food  can  be 
satisfied  by  substituting  barley  or  some  other  cereal. 
The  existence  of  substitutes,  therefore,  will  tend  to 
make  an  inelastic  demand  elastic. 

Let  us  consider  once  more  our  illustration  of  the  coal 


VALUE  131 

supply  and  demand.  Coal  has,  as  we  have  said,  many 
uses.  Take  its  use  as  fuel.  In  our  climate  fuel  is  a 
necessity.  If  coal  were  the  only  form  of  fuel,  it  would 
be  an  absolute  physical  necessity,  and  its  demand,  there- 
fore, would  be  inelastic.  But  there  exist  many  other 
forms  of  fuel.  It  might  happen,  for  example,  that  the 
price  of  coal  was  high  while  oil  was  cheap.  The  demand 
for  coal  would  be  transferred  to  oil.  If  we  suppose 
that  coal  is  regarded  as  the  best  form  of  fuel,  then  as 
soon  as  the  price  of  coal  approached  that  of  oil,  the 
former  oil-users  would  change  to  coal,  thus  increasing 
the  demand.  Consequently  the  demand  for  coal  in- 
stead of  being  inelastic,  is  elastic. 

In  all  considerations  of  the  elasticity  of  demand  the 
presence  of  substitutes  must  be  taken  into  account. 

The  same  argument  which  has  just  been  applied  in 
regard  to  the  elasticity  of  demand  applies  with  equal 
force  to  the  elasticity  of  supply.  The  higher  the  price, 
the  greater  will  be  the  effective  supply,  but  in  the  case 
of  some  commodities  a  small  increase  in  price  will  cause 
a  large  addition  to  the  supply,  while  in  others  it  takes 
a  very  considerable  rise  in  price  to  affect  materially 
the  supply.  In  the  case  of  those  goods  which  require 
a  large  fixed  capital  to  secure  efficient  production,  if 
the  actually  existing  supply  is  equaled  or  nearly 
equaled  by  the  demand,  it  will  require  a  considerable 
rise  in  price  to  cause  new  production.  A  small  rise 
will  probably  not  be  sufficient  to  encourage  manu- 
facturers to  invest  new  capital  in  the  manufacture  of 
the  particular  articles  in  question,  but  a  large  increase 
will  tempt  them  to  start  new  factories  so  as  to  reap 
some  of  the  profits  due  to  the  increase  in  prices. 


132  AN  INTRODUCTION   TO   ECONOMICS 

At  the  same  time  if  there  are  efficient  substitutes, 
a  small  increase  in  price  will  tend  to  encourage  the 
manufacture  of  those  substitutes,  provided  the  fixed 
capital  required  for  such  production  is  not  so  expensive 
as  that  required  for  the  article  itself. 


CHAPTER  XI 

THE   LAW   OF    SUPPLY   AND   DEMAND 

It  is  frequently  asserted  that  prices  are  governed  by 
the  law  of  supply  and  demand.  In  the  last  chapter 
it  was  shown  that  the  terms  supply  and  demand  were 
not  quite  so  simple  as  they  would  appear  to  be.  Be- 
fore we  can  understand  exactly  what  is  meant  by  the 
law,  we  must  examine  very  carefully  the  theory  of  the 
competitive  system  of  distribution.  That  can  best 
be  done  by  taking  simple  illustrations. 

The  Factors  of  Exchange  —  Suppose  there  are  two 
schoolboys  one  of  whom  possesses  more  oranges  than 
he  desires  and  the  other  a  similar  superfluity  of  apples. 
There  is  here  a  possibility  of  an  exchange  of  oranges  for 
apples.  Let  us  take  first  the  case  of  the  boy  with  the 
oranges.  He  may  or  he  may  not  want  apples.  If  he 
has  no  wish  for  apples,  there  will  be  no  exchange  unless 
he  is  able  to  exchange  apples  for  something  which  he 
does  want.  Assuming,  however,  that  he  does  wish  to  ob- 
tain some  apples,  the  question  which  arises  for  him  is,  how 
many  oranges  is  he  to  give  for  how  many  apples.  This 
will  depend  upon  several  different  factors.  His  desire 
for  apples  may  be  very  strong  or  very  weak  or  medium. 
If  he  has  a  passionate  fondness  for  apples,  it  will  tend  to 
make  him  willing  to  exchange  a  large  number  of  oranges 
for  one  apple.  If  he  has  only  a  very  slight  desire  for 
133 


134  AN  INTRODUCTION   TO   ECONOMICS 

* 

apples,  he  will  only  give  a  small  number  of  oranges  in 
exchange.  If  his  desire  is  only  medium,  then  we  may  to 
a  large  extent  ignore  it  as  a  factor  in  the  exchange,  and 
turn  to  the  next.  He  may  or  he  may  not  be  very  fond 
of  oranges.  The  higher  value  he  places  on  oranges  the 
fewer  is  he  likely  to  offer  for  apples.  Again,  his  supply  of 
superfluous  oranges  may  be  very  large  or  comparatively 
small.  If  it  is  large,  there  will  be  a  tendency  to  offer 
more  oranges  for  an  apple  than  if  it  be  small. 

Still  further,  the  number  of  superfluous  apples  pos- 
sessed by  the  other  boy  may  be  large,  medium,  or  small. 
If  it  be  large,  the  boy  with  the  oranges  will  expect  to 
receive  a  comparatively  larger  number  of  apples  for  his 
oranges,  than  if  it  be  small.  He  may  know,  moreover, 
that  the  boy  with  the  apples  is  either  very  fond  of  apples 
or  not  and  consequently  either  unwilling  or  willing  to 
part  with  this  extra  store.  All  of  which  will  affect 
the  ratio  of  exchange. 

So  far  we  have  considered  only  the  existence  of  two 
boys.  Let  us  suppose,  however,  that  there  are  other 
boys  with  oranges  and  apples.  This  will  complicate  the 
question,  for  the  fact  that  there  are  others  willing  to  ex- 
change oranges  for  apples  will  tend  to  make  the  original 
party  to  the  exchange  modify  his  terms.  If  A  and  B 
possess  oranges  and  C  and  D  apples,  A  will  rather  offer  a 
few  more  oranges  than  B,  in  order  to  obtain  the  apples, 
than  let  B  get  them.  And  the  fact  that  he  can  obtain 
apples  from  either  C  or  D  will  tend  to  make  him  offer 
less  to  C  on  the  ground  that  if  C  does  not  wish  to  sell 
he  can  obtain  all  he  wants  from  D. 

A  further  complication  results  from  the  possibility 
of  A  and  B  preferring  to  satisfy  their  desire  for  fruit 


THE   LAW   OF   SUPPLY  AND   DEMAND  135 

by  taking  pears  rather  than  paying  too  many  oranges 
for  apples.  *d 

We  may  sum  up  the  factors  that  enter  into  the  ex- 
change as  follows :  From  the  buyer's  point  of  view, 
the  factors  are  these  : 

1.  The  buyer's  desire  for  the  other  commodity 

2.  His  desire  for  the  purchasing  commodity  (apples  in  our 
illustration) 

3.  His  supply  of  purchasing  goods 

4.  The  supply  of  the  other  commodity 

5.  The  desire  of  the  seller  for  the  goods  he  sells 

6.  The  desire  of  the  seller  for  the  purchasing  goods 

7.  The  presence  of  other  buyers  and  sellers  in  the  market 

8.  The  presence  of  substitutes 

In  the  exchange  as  we  have  described  it,  both  parties 
are  buyers  and  sellers  at  the  same  time.  This  is  es- 
sentially true  of  all  exchanges,  no  matter  how  they  are 
conducted,  so  the  point  of  view  of  him  whom  we  have 
called  the  buyer  in  our  illustration  is  the  same  as  the 
seller.  In  practice,  however,  unless  we  are  dealing 
with  a  case  of  simple  barter,  which  is  common  among 
schoolboys,  the  exchange  is  carried  on  by  means  of  an 
intermediate  commodity  which  we  call  money,  usually 
a  scarce  commodity  with  schoolboys.  This,  as  we 
shall  see  in  a  later  chapter,  does  not  affect  the  argument. 

Strong  and  Weak  Buyers  and  Sellers  —  When  we 
consider  a  larger  market  than  that  implied  in  the  above 
discussion,  we  shall  readily  understand  that  there  are 
many  ratios  of  exchange.  The  governing  factors  are 
not  the  same  for  all  of  the  buyers,  nor  for  all  of  the 
sellers.  One  boy  may  be  a  strong  buyer,  that  is,  his 
desire  for  oranges  may  be  very  strong  while  his  desire 


136  AN  INTRODUCTION  TO  ECONOMICS 

for  apples  is  weak.  Another  may  care  very  little  for 
oranges  and  a  great  deal  for  apples.  And  similarly 
there  may  be  a  difference  between  the  desire  on  the 
part  of  the  possessors  of  apples.  The  quantities  of 
oranges  possessed  by  one  may  not  be  so  great  as  those 
possessed  by  others,  and  so  forth.  So  there  may  easily 
be  exchanges  between  some  of  the  orange  dealers  and 
some  of  the  apple  sellers  and  not  between  others,  and 
the  ratios  of  exchange,  where  exchange  actually  takes 
place,  will  not  be  the  same. 

To  vary  the  illustration  and  to  bring  in  the  question 
of  price  let  us  recur  to  the  variations  in  the  price  of 
coal.  As  we  suggested  in  the  last  chapter  there  are 
some  people  who  must  have  coal  no  matter  what  the 
price  is.  If  the  price  be  very  high,  however,  only  those 
who  absolutely  must  have  the  coal  will  buy  it.  "\Vlicn 
the  price  falls,  other  buyers  whose  needs  are  not  quite 
so  imperative  will  purchase  coal,  and  the  farther  the 
price  falls,  the  more  buyers  will  there  be,  until  all  have 
satisfied  their  desires. 

Let  us  suppose  that  the  high  price  of  coal  is  twenty 
dollars  a  ton.  At  that  price  there  are  buyers  for,  say,  one 
thousand  tons.  Should  the  price  fall  to  fourteen  dollars 
there  will  be  purchasers  for  four  thousand  tons.  We  may, 
for  the  sake  of  example,  tabulate  a  series  of  prices  with 
the  amounts  for  which  there  are  purchasers,  as  follows  : 

PRICE  op  A  TON  NUMBER  OF  TONS  DEMANDED 

$20  1000 

14  4000 

8  9000 

5  14,000 

2  21,000 


THE   LAW   OF   SUPPLY   AND   DEMAND 


137 


The  Demand  Curve  —  This  situation  may  be  con- 
veniently studied  by  means  of  a  graph  or  curve,  as  in 
Figure  3.  This  figure  is  drawn  on  paper  ruled  into 
squares.  Following  the  ruled  lines  we  have  two  straight 
lines,  OX  and  OY,  at  right  angles  to  each  other,  meet- 
ing in  the  point  0.  Now  let  us  assume  that  each 


division  in  the  direction  OX  represents  a  given  number 
of  tons,  say  one  thousand.  Each  division  in  the  direc- 
tion OY  represents  a  price  per  ton,  say  one  dollar. 

Referring  to  the  table  we  see  that  the  first  price  was 
twenty  dollars  a  ton.  We  therefore  count  up  twenty 
spaces  in  the  direction  OY,  starting  from  the  point  0. 
The  number  of  tons  taken  at  that  price  was  one  thou- 


138  AN  INTRODUCTION   TO  ECONOMICS 

sand.  We  therefore  move  one  space  in  a  direction 
parallel  to  OX  and  there  mark  a  point.  The  second 
price  was  fourteen  dollars.  We  count  up  toward  Y 
fourteen  spaces,  and,  as  four  thousand  tons  were  taken 
at  that  figure,  we  mark  our  second  point  four  spaces 
along  in  the  direction  of  X. 

In  a  similar  manner  we  mark  the  points  correspond- 
ing to  the  remaining  figures  in  the  table.  These  points 
are  obviously  not  in  a  straight  line.  If  we  join  the 
points  the  result  will  be  a  series  of  short,  straight  lines. 
But  this  would  indicate  that  the  movement  of  de- 
mand was  jerky,  which  is  hardly  probable.  If  we  had 
taken  more  figures  we  should  have  arrived  at  a  further 
series  of  points  filling  up  the  gaps  between  the  five 
points  taken  and  it  would  appear  that  the  demand, 
moving  gradually  as  the  price  falls,  would  follow  the 
same  general  direction  as  the  five  points  taken,  that 
is  to  say,  they  would  follow  a  curved  line  passing 
through  the  five  points.  Such  a  curve  we  may  call 
the  demand  curve  for  coal,  according  to  the  figures  in 
our  table. 

If  this  demand  curve  truly  represents  the  relation 
between  the  price  of  coal  and  the  amount  purchasers 
are  willing  to  take,  then  we  may  obtain  data  regarding 
other  prices  than  those  in  our  table.  For  example, 
suppose  the  price  is  eleven  dollars  a  ton.  The  hori- 
zontal line  drawn  from  the  eleventh  space  touches  the 
curve  at  the  sixth  vertical  line.  There  will,  therefore, 
be  a  demand  for  six  thousand  tons  of  coal  at  that  price. 
The  total  price  paid  for  the  coal  will  be  represented 
by  the  rectangle  contained  by  the  horizontal  and 
vertical  lines  which  touch  the  curve.  In  our  last  ex- 


THE   LAW   OF   SUPPLY  AND   DEMAND  139 

ample,  the  rectangle  PP'TO  represents  the  amount 
paid  for  coal  at  eleven  dollars  a  ton,  sixty-six  thou- 
sand dollars. 

Consumer's  Surplus  —  Let  us  suppose  that  eleven 
dollars  is  the  actual  price  paid  at  a  given  time.  Total 
purchases  amounting  to  six  thousand  tons  are  taken. 
But  the  purchasers  of  one  thousand  tons  out  of  this 
six  thousand  would  have  been  willing  to  pay  as  high 
as  twenty  dollars  a  ton  if  they  had  been  forced  to  do 
so.  They  have  made  an  actual  expenditure  of  eleven 
thousand  dollars  instead  of  a  possible  expenditure  of 
twenty  thousand  dollars.  They  are,  therefore,  in 
pocket  to  the  extent  of  the  difference,  nine  thousand 
dollars.  This  difference  between  the  amount  actually 
paid  and  the  amount  that  the  purchasers  would  have 
paid  rather  than  forego  the  use  of  the  coal,  is  termed 
the  consumer's  surplus.  The  total  amount  of  this 
consumer's  surplus  may  be  obtained  from  the  figure 
by  simply  calculating  the  area  inclosed  between  the 
lines  PP',  the  curve,  and  PY,  taking  Y  as  the  point  at 
which  the  curve  touches  the  line  OY. 

It  will  be  noticed  that  we  have  carefully  refrained 
from  using  the  phrase  amount  of  coal  sold,  and  have 
used  instead  the  expression  amount  which  the  pur- 
chasers were  willing  to  take.  Because  there  are  pur- 
chasers for  a  certain  amount  at  a  given  price  it  does 
not  follow  that  there  are  the  same  number  of  sellers 
at  that  price.  There  will  be  many  more  sellers  willing 
to  part  with  their  coal  when  the  price  is  twenty  dollars 
a  ton  than  when  it  is  ten  dollars.  As  the  price  falls 
the  amount  of  coal  available  to  purchasers  falls  also. 
The  strong  holders  will  hold  their  coal  until  a  higher 


140  AN  INTRODUCTION   TO   ECONOMICS 

price  obtains,  the  weaker  selling  when  the  price  seems 
sufficient  to  them. 

The  Supply  Curve  —  We  may  tabulate  the  amount 
of  coal  available,  that  is,  the  effective  supply,  as  we 
did  the  effective  demand.  The  table  below  may  serve 
as  illustration. 

PKICE  OF  A  TON  NUMBER  OP  TONS  AVAILABLE  FOR  SALE 

$  2  2000 

5  14,000 

8  18,000 

14  22,000 

20  24,000 

These  figures  may  be  plotted  as  a  curve  in  a  similar 
manner  to  that  in  which  the  demand  curve  was  drawn. 
The  result  is  shown  in  Figure  4.  From  this  curve  the 
supply  available  at  different  prices  can  be  seen.  At 
a  price  of  eleven  dollars  a  ton,  for  instance,  the  amount 
available  is  between  twenty  thousand  and  twenty-one 
thousand  tons,  say  twenty  thousand,  five  hundred  tons. 

Producer's  Surplus  —  Let  us  suppose  that  the  price 
is  fixed  at  eight  dollars  a  ton.  At  that  figure  the 
amount  of  coal  available  is  eighteen  thousand  tons. 
The  total  price  received,  therefore,  is  eighteen  thousand 
multiplied  by  eight  dollars,  or  one  hundred  and  forty- 
four  thousand  dollars.  But  there  were  merchants  who 
were  willing  to  sell  two  thousand  tons  even  if  the  price 
were  as  low  as  two  dollars  a  ton.  That  is,  they  would 
have  been  willing  to  receive  four  thousand  dollars,  but 
they  actually  receive  sixteen  thousand  dollars.  The 
additional  price  received  above  their  minimum  is,  there- 
fore, twelve  thousand  dollars  which  is  the  producer's 
surplus.  There  is,  of  course,  a  different  producer's 


THE   LAW   OF   SUPPLY  AND   DEMAND 


141 


surplus  for  each  producer,  according  as  the  minimum 
at,  which  he  will  sell  his  coal  varies.  The  total  pro- 
ducer's surplus  at  any  given  price  may  be  seen  from 
the  curve.  The  area  included  between  the  lines  OT, 
TPf  and  the  curve  OP',  taking  the  point  0  as  the  point 


where  the  curve  meets  the  line  OX,  represents  the  total 
producer's  surplus  at  the  price  of  eight  dollars  a  ton. 
Market  Price  —  These  two  curves,  however,  merely 
>resent  the  variations  in  supply  and  demand.     The 
mestion  we  wish  to  solve  is  this :  What  is  the  actual 


142 


AN  INTRODUCTION   TO   ECONOMICS 


price  at  which  the  coal  will  be  sold  under  the  conditions 
represented  in  the  tables,  or  by  the  curves?  If  there 
are  any  actual  sales  there  must  be  an  equality  between 
the  amount  sold  and  the  amount  bought.  This  is  ob- 
vious. Now  there  is  only  one  point  at  which  the 
amount  available  is  equal  to  the  amount  demanded, 
that  is,  the  point  at  which  the  price  is  five  dollars  a  ton. 


This  will  most  readily  be  seen  if  one  curve  is  super- 
imposed upon  another,  as  in  Figure  5.  The  curves 
cross  one  another  on  the  price  line  of  five  dollars.  At 
that  point  the  demand  is  for  fourteen  thousand  tons 
and  the  supply  is  also  fourteen  thousand  tons.  The 
natural  assumption,  therefore,  is  that  the  price  at 
which  coal  will  be  sold  is  five  dollars  a  ton. 


THE   LAW  OF   SUPPLY  AND   DEMAND          143 

Definition  of  Term  "  Market "  -  This  price  is 
termed  the  market  price  of  coal.  We  have  used  the 
term  market  several  times  now  without  having  def- 
initely determined  what  meaning  we  give  to  the  term. 
As  usual,  there  are  many  meanings  which  may  be  at- 
tached to  the  word.  A  market  may  mean  a  building 
in  which  goods  are  sold.  In  the  case  of  a  meat  market, 
for  example,  it  will  depend  upon  the  person  who  uses 
the  term  whether  he  means  a  building  in  which  meat 
is  displayed  for  sale,  or  the  district  in  which  a  man 
may  dispose  of  meat.  Sometimes  the  word  is  even 
used  instead  of  the  word  price.  It  is  important  that 
we  should  limit  the  term  to  one  meaning  in  order  that 
our  discussion  should  be  accurate.  We  must  leave 
to  colloquial  speech  the  idea  of  a  market  being  a  build- 
ing, or  representing  a  price.  In  the  economic  sense 
a  market  is  the  area  in  which  all  buyers  and  sellers 
have  equal  opportunity  for  obtaining  information  re- 
garding the  demand  for,  and  supply  of,  a  given  com- 
modity, and  also  equal  facilities  for  buying  or  selling 
that  commodity. 

In  some  cases  the  market  represents  a  very  wide 
area  and  in  others  it  is  very  restricted.  The  wheat 
market,  for  example,  is  almost  as  wide  as  the  world. 
American  dealers  know  the  European  demand  and 
supply;  they  know  also  how  much  wheat  Australia 
and  Russia  are  able  to  offer  for  sale,  and  how  much 
they  are  likely  to  want  for  themselves.  A  similar 
knowledge  exists  in  Europe,  Australia,  and  Russia. 
Wheat  is  readily  bought  by  Europeans  in  America  or 
in  Australia  and  vice  versa,  so  we  have  all  the  con- 
ditions requisite  to  form  a  market.  On  the  other  hand, 


144  AN  INTRODUCTION   TO   ECONOMICS 

the  fresh  vegetable  market  is  purely  local.  No  one 
in  New  York,  for  example,  is  interested  in  the  fresh 
vegetable  supplies  in  central  California.  By  the  time 
those  vegetables  could  reach  New  York  they  would 
cease  to  be  fresh.  Hence  there  is  a  definitely  restricted 
area  in  which  the  fresh  vegetables  may  be  bought  and 
sold. 

In  considering  the  market  price  it  must  always  be 
remembered  that  we  are  not  dealing  with  the  results 
of  any  individual  bargain.  There  are  variations  in 
the  skill  at  bargaining  which  will  offset  some  of  the 
effects  resulting  from  a  pure  consideration  of  supply 
and  demand.  A  weak  buyer,  for  example,  may  be 
able  by  his  skill  to  hide  his  weakness  and  convey  an 
idea  of  strength  to  the  seller,  and  so  obtain  a  lower 
price  than  would  otherwise  be  the  case ;  and  the  re- 
verse is  also  true.  But  these  individual  variations  in 
skill  will  tend  to  cancel  one  another  when  we  consider 
the  total  sales  made.  It  is  not  to  be  expected  that 
the  bulk  of  the  skill  will  lie  with  either  the  buyers  or 
the  sellers;  it  will  probably  be  equally  divided  be- 
tween both.  So  the  number  of  weak  buyers  able  to 
hide  their  weakness  will  be  neutralized  by  the  number 
of  weak  sellers  who  convey  an  impression  of  strength. 

Limits  of  Price  Fluctuations.  Normal  Price  — 
Market  price  fluctuates  from  day  to  day  and,  in  some 
instances,  from  hour  to  hour.  Its  variations,  however, 
have  limits  Let  us  take  the  case  of  the  production  of 
automobiles.  Here  the  fluctuations  in  market  price 
are  not  very  wide,  but  they  exist.  Now  there  are 
engaged  in  the  production  of  motor  cars  many  dif- 
ferent firms,  working  at  varying  rates  of  profit.  At 


THE   LAW   OF   SUPPLY  AND   DEMAND  145 

a  given  price  for  a  machine  of  a  certain  standard  of 
quality  one  firm  will  make  a  high  profit  and  another 
will  make  just  sufficient  to  encourage  it  to  keep  on  pro- 
ducing. Now  as  the  market  price  for  this  particular 
machine  falls,  it  will  mean  that  those  firms  which  were 
working  at  the  minimum  profit  will  cease  to  produce. 
The  new  price  renders  it  impossible  for  them  to  gain 
the  minimum  rate.  But  this  will  mean  a  reduction 
in  the  amount  of  machines  produced,  or,  in  other  words, 
a  fall  in  supply.  And  this  in  turn  will  naturally  tend 
toward  preventing  a  further  fall  in  price,  if  not  in  pro- 
ducing an  actual  increase  in  price. 

Again,  if  the  market  price  should  show  a  tendency 
to  a  steady  rise,  the  increased  profits  resulting  from 
this  rise  in  price  will  tempt  capitalists  to  invest  new 
capital  in  the  production  of  similar  machines,  and  hence 
result  in  an  increase  in  supply.  This,  in  its  turn,  will 
tend  to  prevent  the  further  increase  in  price  or  even  to 
cause  a  fall.  There  is,  therefore,  an  upper  and  a  lower 
limit  beyond  which  the  market  price  cannot  rise  or  fall 
for  any  length  of  time.  For  a  short  period,  and  owing 
to  conditions  which  are  of  a  temporary  nature,  it  is 
possible  for  the  market  price  to  fall  below  or  to  rise 
above  these  limits,  but  this  is  only  true  for  a  short 
time.  If  the  fall  or  rise  seems  likely  to  continue, 
then  the  effects  above  described  will  inevitably  be 
realized. 

There  is,  then,  a  price,  or  rather  a  range  of  prices,  at 
which  the  normal  production  will  be  kept  up  without 
either  increase  or  decrease.  This  price  is  termed  the 
normal  price.  Normal  price  has  no  effect  upon  any 
given  market  price.  All  that  it  does  is  to  set  a  general 


146  AN  INTRODUCTION   TO   ECONOMICS 

limit  beyond  which  market  prices  cannot  fluctuate  for 
more  than  a  very  short  period. 

From  this  discussion  it  would  appear,  therefore,  that 
in  the  long  run,  prices  are  determined  by  cost  of  pro- 
duction. If  the  price  falls  so  low  that  the  cost  of  pro- 
duction is  not  realized,  production  will  to  a  certain 
extent  cease,  and,  therefore,  supply  will  be  reduced  and 
so  check  the  tendency  to  fall  further.  If  the  price 
rises  very  high  above  cost  of  production,  new  capital 
will  come  in  to  produce  more  goods,  so  increasing  the 
supply  and  producing  a  tendency  to  lower  prices. 

The  foregoing  discussion  of  the  law  of  supply  and 
demand  rests  upon  certain  assumptions  which  are  not 
always  justified  by  the  actual  conditions  of  exchange. 
First  is  the  assumption  that  all  exchange  is  carried  on 
under  conditions  of  free  and  unhampered  competition. 
This,  as  we  have  seen  in  a  previous  chapter,  is  not  the 
case.  There  is  no  such  thing  as  entirely  free  competi- 
tion to-day.  Any  country  grocer  will  readily  admit 
that  he  has  to  sell  certain  goods  at  a  price  in  determin- 
ing which  he  has  had  no  say.  Monopoly  after  monopoly 
is  attempted  with  the  very  definite  end  in  view  of  pre- 
venting a  competitive  fixing  of  prices.  It  is  true  that 
perfect  and  absolute  monopoly  does  not  exist,  but  the 
nearer  the  attempts  approach  to  the  ideal,  the  further 
is  the  departure  from  the  competitive  price  fixing  under 
the  law  of  supply  and  demand.  The  question  of 
monopoly  price,  however,  will  concern  us  in  the  next 
chapter.  Here  it  must  merely  be  noted. 

A  second  consideration  arises  in  the  variations  in 
the  knowledge  of  possibilities  of  cheaper  supplies  on 
the  part  of  the  buyers,  or  higher  prices  for  the  sellers. 


THE   LAW   OF   SUPPLY  AND   DEMAND  147 

This  is  realized  by  advertisers  who  strive  to  obtain  the 
widest  publicity  for  the  goods  they  are  trying  to  sell. 
It  is  realized  that  there  may  be  many  buyers  for  these 
goods  who  do  not  know  of  their  existence  and  are  buy- 
ing similar  goods  at  a  higher  price. 

The  Flow  of  Capital  —  This  lack  of  competition  and 
of  knowledge  as  to  the  conditions  of  supply  and  demand 
affects  particularly  market  price,  but  normal  price  is 
affected  also.  Following  the  purely  theoretic  discussion 
of  the  determination  of  normal  price  which  has  been 
given  above,  it  would  seem  that  the  moment  prices 
rose  to  a  point  which  permitted  of  profits  above  the 
normal  rate,  new  capital  would  be  drawn  into  the  pro- 
duction to  take  advantage  of  these  increased  profits. 
In  practice,  however,  this  is  not  always  the  case.  The 
increased  profits  may  not  be  general  knowledge,  and 
those  who  are  reaping  them  will  do  all  in  their  power 
to  prevent  the  knowledge  becoming  general.  Hence 
the  price  may  stay  above  the  normal  level  for  a  con- 
siderable period.  Ultimately,  it  is  bound  to  be  dis- 
covered. But  even  then  the  question  will  arise  as  to 
whether  the  increased  production  will  not  bring  down 
prices  below  the  level  necessary  for  normal  profits. 
Capital  is  said  to  flow  toward  industries  which  yield 
high  profits.  The  flow  is  not  the  even  flow  of  a  river 
in  the  lowlands,  however.  It  is  more  comparable  to 
a  stream  falling  down  a  mountain  side.  At  places  it 
forms  deep  pools  which  brim  over  and  the  water  falls 
in  a  cataract.  Like  most  new  streams,  too,  its  speed 
and  its  variations  are  greatest  also  in  the  early  stages 
of  industries.  A  thin  trickle  of  capital  flows  towards 
the  production  of  some  new  invention  or  industry  — 


148  AN  INTRODUCTION   TO   ECONOMICS 

like  the  production  of  moving  pictures,  for  instance. 
Suddenly  the  stream  tumbles  down  the  mountain  side, 
being  filled  from  other  sources  until  the  stream  of 
capital  is  broad  and  deep  and  the  rate  of  increase 
correspondingly  slow. 

All  these  correctives  must  be  taken  into  account  in 
considering  the  true  working  of  the  law  of  supply  and 
demand.  But  this  does  not  entirely  detract  from  the 
value  of  the  law.  If  you  take  an  iron  ball  and  suspend 
it  by  a  string  it  will,  obeying  the  law  of  gravity,  hang 
in  a  vertical  line  drawn  to  the  earth  from  the  point  of 
suspension.  But  if  you  surround  that  iron  ball  with 
a  series  of  electromagnets  and  constantly  vary  the 
currents  flowing  through  those  magnets  the  ball  will 
be  drawn  from  its  position  and  will  constantly  vary 
that  position  as  the  attracting  magnetic  force  varies 
in  each  of  the  magnets.  This  does  not  affect  the  truth 
of  the  law  of  gravitation.  Similarly,  although  there 
are  many  causes  operating  to  deflect  and  to  hide  the 
effects  of  the  law  of  supply  and  demand,  the  law  is 
constantly  working  nevertheless.  What  must  be  real- 
ized, however,  is  that  to  speak  in  a  loose  way  of  the 
law  of  supply  and  demand  regulating  prices  is  to  show 
ignorance  of  the  very  many  other  factors  which  tend  to 
vary  the  price  of  commodities  both  in  long  and  short 
periods. 


CHAPTER  XII 
MONOPOLY  AND   MONOPOLY  PRICE 

It  has  been  made  sufficiently  clear  in  previous 
chapters  that  the  tendency  of  modern  development 
is  towards  the  elimination  of  competition.  While  it 
was  true  that  under  free  competition  there  was  a 
reasonable  prospect  of  the  consumer  reaping  the  im- 
mediate advantages  in  the  shape  of  reduced  prices,  it 
has  been  contended  that  the  ultimate  advantage  to 
the  consumer  did  not  rest  with  the  competitive  system. 
The  free  action  of  the  law  of  supply  and  demand  in  a 
full  competitive  system  tended  to  reduce  prices  to  a 
level  which  was  barely  sufficient  to  keep  production 
going  on.  Manufacture  was  too  close  to  the  margin 
of  productivity.  That  is  to  say,  each  of  the  manu- 
facturers was  working,  or  tended  to  work,  too  close  to 
that  point  at  which  profits  disappeared,  and  so  there 
was  always  the  possibility  that  some  few  or  many 
would  be  compelled  to  drop  out  of  business. 

Importance  of  Stability  *of  Prices  —  It  is  to  the 
general  advantage  of  the  consumer  that  prices  should 
be  maintained  at  a  steady  level.  In  the  long  run  this 
is  best,  even  if  the  level  of  prices  be  rather  high.  This 
question  of  stability  of  prices  is  one  with  which  we 
shall  deal  later  on  in  the  discussion  of  the  relation  of 
money  to  prices.  At  present  it  should  be  noted  that 
when  a  person  contracts  to  do  a  certain  piece  of  work 
149 


150  AN  INTRODUCTION   TO   ECONOMICS 

it  is  absolutely  essential  that  he  should  know  what 
prices  he  must  pay  for  his  materials.  If  these  prices 
are  constantly  fluctuating,  as  they  undoubtedly  would 
fluctuate  under  the  free  play  of  the  law  of  supply  and 
demand,  it  makes  the  work  of  estimating  costs  ex- 
tremely difficult,  and  as  a  rule  the  contractor  will  feel 
bound  to  protect  himself  by  estimating  upon  the  safe 
side,  that  is,  by  charging  higher  prices.  Whether  we 
believe  monopoly  in  general  to  be  good  or  bad,  how- 
ever, we  have  to  admit  the  fact  that  the  tendency 
toward  this  form  of  organization  exists,  and  it  remains 
for  us,  at  present,  to  examine  its  nature. 

The  great  evils  which  the  protagonists  of  monopoly 
organization  declare  to  result  from  competition  may 
be  summed  up  in  very  few  words  —  low  prices  and 
waste.  From  the  point  of  view  of  the  consumer,  pro- 
vided production  is  maintained,  low  prices  are  any- 
thing but  an  evil.  On  the  other  hand,  waste  is  an  evil 
from  whatever  point  of  view  it  may  be  taken.  Ad- 
mitting, for  the  sake  of  the  argument,  that  low  prices 
tend  to  cause  restriction  of  production,  we  may  admit 
the  possibility  that  monopolistic  organization  secures  an 
improvement.  But  that  very  admission  constitutes 
the  fundamental  criticism  of  monopolies,  the  criticism 
that  they  raise  prices. 

High  prices  cannot  be  maintained,  however,  unless 
there  is  some  restriction  in  the  free  play  of  competition, 
so  there  is  evidently  a  close  connection  between  monopo- 
lies and  restriction  of  competition.  The  term  itself, 
taken  in  its  strict  interpretation,  signifies  the  entire 
absence  of  competition.  This  is  seldom  realized  in 
practice,  however,  but  it  is  approximated  and  we  may 


MONOPOLY  AND  MONOPOLY  PRICE     151 

use  the  term  in  a  somewhat  looser  sense  without  damage 
to  our  argument. 

Varieties  of  Monopolies  —  Monopolies  are  of  various 
kinds.  There  are  temporary  monopolies  as  contrasted 
with  those  which  have  a  relatively  permanent  exist- 
ence. There  are  monopolies  granted  expressly  by 
government  as  a  reward  for  services  or  as  a  protection 
against  unfair  treatment,  and  those  which  have  been 
brought  about  by  agreement  between  private  indi- 
viduals or  corporations.  We  may  deal  with  the  least 
important  first. 

Monopolies  by  Royal  Grant  —  The  advantage  of 
being  the  only  person  who  can  deal  in  a  commodity 
is  obvious,  and  it  was  no  less  obvious  in  the  Middle 
Ages.  Kings  and  dukes  were  wont  to  grant  rights  of 
monopoly  to  favorites  to  the  great  enrichment  of  the 
latter,  and  to  the  still  greater  disgust  of  their  subjects. 
Even  Queen  Elizabeth,  who  was  probably  as  popular 
a  monarch  as  ever  lived,  had  to  give  way  to  the  de- 
mands of  the  people  for  the  removal  of  this  kind  of 
monopoly.  The  monopoly  of  selling  salt,  for  instance, 
weighed  heavily  upon  a  people  who  had  no  other  means 
of  preserving  meat  than  by  salting.  A  high  price,  and 
those  medieval  monopolists  were  never  very  delicate 
in  their  price  manipulations,  might  easily  mean  ruin. 
Such  monopolies  have  now  ceased,  although  no  doubt 
there  are  courtiers  yet  who  wish  they  were  still  possible. 

Patents  and  Copyrights  —  This  does  not  mean,  how- 
ever, that  governments  have  ceased  to  grant  monopolies. 
Every  civilized  country  has  a  system  of  monopolies  con- 
trolled by  the  government  through  the  patent  laws. 
A  patent  is  nothing  more  nor  less  than  a  monopoly 


152  AN  INTRODUCTION   TO   ECONOMICS 

right  of  production  and  sale.  The  argument  is  this. 
An  inventor  or  author  or  dramatist  has  given  of  his 
time  and  thought,  and  possibly  of  his  money  also,  to 
the  production  of  a  new  instrument  or  book  or  play. 
In  so  doing  he  has  rendered  a  service  of  more  or  less 
value  to  the  community,  and  the  community  should 
pay  for  that  service  to  the  person  who  rendered  it. 
In  the  case  of  the  invention  of  a  new  machine,  the 
government  says,  in  effect,  here  is  a  new  machine 
which  may  or  may  not  be  valuable.  If  it  is,  those  who 
find  it  so  ought  to  pay  the  inventor  for  discovering  it. 
The  only  way  to  find  out  whether  it  is  valuable  is  to 
try  it  out  in  use.  Let  the  inventor  have  the  sole  right 
of  manufacturing  and  selling  this  machine.  If  the 
public  finds  it  valuable,  it  will  pay.  If  it  should  be  a 
useful  machine,  it  would  not  be  fair  to  allow  any  one 
who  so  wished  to  manufacture  it  and  to  reap  the  re- 
ward due  to  the  inventor.  In  order  to  protect  the 
public  from  extortion  on  the  part  of  the  inventor  and 
at  the  same  time  reap  the  fruits  of  the  effort  of  his 
brains,  the  exclusive  right  is  limited  to  a  term  of  years. 

The  same  is  true  of  an  author.  He  writes  a  book 
which  the  public  may  buy  if  it  wishes.  If  it  should 
prove  a  success,  that  is,  if  the  public  should  demand  the 
book  in  large  numbers,  it  would  be  unfair  to  allow  any 
printer  who  so  desired  to  print  cheap  copies  and  cir- 
culate them  by  selling  at  a  comparatively  low  price, 
thus  preventing  the  author  from  receiving  the  reward 
due  to  his  labor. 

These  monopolies  are  rightly  limited  in  time,  how- 
ever. For  it  is  manifestly  unfair  that  a  man's  heirs  in 
perpetuity  should  keep  on  receiving  a  reward  for  the 


MONOPOLY  AND   MONOPOLY   PRICE  153 

deeds  of  their  ancestor.  It  is  not  only  the  inventor 
or  author  himself  who  must  be  protected,  however. 
The  inventor  may  be  quite  willing  to  forego  any  rights 
of  his  own.  Herbert  Spencer,  the  great  philosopher, 
found  this  out  through  personal  experience.  He  was 
a  lover  of  music  and  was  annoyed  at  the  unsatisfactory 
clips  on  the  music  stands  which  he  used.  So  he  in- 
vented one  of  his  own  which  proved  perfectly  satis- 
factory. He  did  not  want  to  make  any  money  out 
of  the  idea,  but  when  he  tried  to  find  a  manufacturer 
to  produce  the  clip  so  that  other  music  lovers  could 
avoid  a  similar  annoyance,  he  found  that  the  manu- 
facturer insisted  on  a  patent  being  taken  out.  If  there 
were  no  patent,  the  manufacturer  claimed  that  he 
would  not  be  able  to  gain  a  reasonable  profit  on  the 
risk  that  he  ran,  for  should  the  clip  prove  a  failure  the 
loss  would  be  all  his  own,  and  should  it  prove  a  success 
other  manufacturers  would  step  in  and  take  away  a 
great  part  of  his  sales. 

Trade  Marks  —  Another  form  of  monopoly  is  worth 
mentioning  before  we  treat  of  the  form  to  which  the 
term  is  commonly  applied.  Governments  in  most 
countries  provide  for  the  exclusive  use  of  trade  marks. 
The  owner  of  a  trade  mark  has  the  sole  use  of  that 
particular  sign  with  which  to  mark  his  goods.  This  is 
a  protection  to  him  and  is  very  rightly  given  as  such. 
If  a  firm  has  spent  a  great  deal  of  trouble  building  up 
a  business  which  is  recognized  as  a  sound  one,  in  pro- 
ducing goods  which  win  popular  approval,  or  has  gone 
to  great  expense  in  advertising  these  goods,  it  is  hardly 
fair  that  it  should  be  deprived  of  the  fruits  of  that 
labor  and  expense.  In  order  to  distinguish  its  goods 


154  AN  INTRODUCTION   TO   ECONOMICS 

from  those  sold  by  competitors,  a  firm  marks  those 
goods  by  some  distinguishing  sign  or  name,  by  which 
they  become  well  known  as  the  reputation  of  the  pro- 
ducer grows.  If  there  were  no  provision  for  copy- 
righting the  distinguishing  sign,  other  merchants  or 
manufacturers  might  use  it  for  their  own  productions 
and  thus  sell  goods  to  consumers  on  the  reputation 
gained  by  their  more  successful  competitor. 

A  soap  company,  for  example,  may  manufacture  a 
soap  which  they  call  "  Imperial."  If  the  public  de- 
cides that  this  is  a  good  soap  they  will  buy  it  steadily, 
and  gradually  the  name  will  become  familiar  as  repre- 
senting a  desirable  variety.  Realizing  that  consumers 
are  in  the  habit  of  asking  for  "  Imperial  "  soap  an- 
other manufacturer  might  label  his  production  "  Im- 
perial "  also  and  so  sell  large  quantities  to  those  who 
thought  they  were  getting  the  goods  manufactured  by 
his  rival.  This  is  so  manifestly  unfair  that  trade  marks 
may  be  registered  and  copyrighted,  and  the  owners 
are  protected  against  the  use  of  their  trade  mark  or 
one  so  similar  as  to  be  easily  confused  with  it. 

This  form  of  exclusive  use,  however,  is  not  true 
monopoly.  For  while  the  Imperial  Soap  Company 
has  the  exclusive  right  to  the  use  of  the  word  "  Im- 
perial "  it  has  no  exclusive  right  to  the  manufacture 
of  soap.  Competition  still  exists  and  the  Imperial 
Soap  must  take  its  chance  with  the  Regal  and  the  Re- 
publican and  all  the  other  possible  brands. 

Monopoly  of  Location  — Nor  is  the  sole  right  to 
have  a  store  in  a  certain  district  rightly  to  be  construed 
as  a  monopoly.  It  is  true  that  it  eliminates  a  certain 
amount  of  competition,  but  the  effect  of  competition 


MONOPOLY  AND   MONOPOLY   PRICE  155 

from  outside  the  monopoly  district  is  bound  to  be 
felt.  If  this  particular  store  charges  too  high  a 
price,  its  customers  can  go  outside  the  district  for 
their  goods. 

If  the  area  be  so  wide,  however,  that  it  is  extremely 
difficult  for  customers  to  go  outside,  then  the  monopoly 
tends  to  be  more  absolute.  This  is  because  it  has  a 
better  control  of  price-making.  It  can  raise  its  prices 
with  less  likelihood  of  customers  buying  elsewhere. 
Now  in  every  one  of  the  cases  we  have  taken,  it  is  ob- 
vious that  what  is  being  sought  is  this  very  power  of 
fixing  prices  without  being  subjected  to  competition. 
This  is  the  essence  of  monopoly.  But  there  is  more 
to  be  considered  before  we  are  able  to  give  a  clear- 
cut  definition.  Even  if  the  power  to  fix  prices  inde- 
pendently of  the  law  of  supply  and  demand  exists  for  a 
time,  that  time  will  be  limited  unless  there  is  a  certain 
minimum  of  control  of  production,  as  well  as  of  dis- 
tribution of  the  monopoly  goods. 

Necessity  of  Control  of  Production  and  Distribu- 
tion —  If  there  is  no  control  of  production,  but  only 
of  distribution,  there  cannot  be  permanent  control  of 
price-fixing,  as  far  as  the  distributors  are  concerned, 
for  the  producers  may  so  raise  their  prices  that  the 
profits  of  high  retail  prices  will  not  be  reaped  by  the 
distributors.  In  order  that  the  monopoly  should  have 
a  chance  of  real  success,  there  should  be  some  measure 
of  control  of  production  also.  In  this  way  there  is  a 
unity  which  the  purely  distributing  side  could  not  pos- 
sess. This  has  been  felt  in  a  great  many  of  the 
monopolies  which  exist  at  present.  The  steel  monopoly, 
for  example,  means  not  merely  the  control  of  the  selling 


156  AN  INTRODUCTION   TO   ECONOMICS 

of  steel,  but  also  the  more  or  less  absolute  control  of 
the  ore  beds,  of  the  rolling  mills,  and  of  the  railroads. 

Definition  of  Monopoly  —  This  qualification,  how- 
ever, merely  emphasizes  the  nature  of  the  control 
necessary  before  those  engaged  in  a  business  can  have 
the  power  to  exercise  definite  control  over  price.  We 
may,  therefore,  define  a  monopoly  as  a  business  group 
which  has  such  unity  of  producing  and  distributing 
organization  as  gives  it  power  to  fix  prices  without 
reference  to  competition. 

It  is  the  aim  of  every  monopoly  so  to  charge  for  the 
goods  it  produces  as  to  reap  the  maximum  profit. 
This  does  not  necessarily  mean  an  increase  in  price. 
It  may  happen,  for  example,  that  the  greatest  profit 
can  be  obtained  by  selling  large  quantities  at  com- 
paratively low  prices.  The  cost  of  production  for  a 
monopoly  organization  should  be,  and  often  is,  less  than 
that  of  competing  manufacturers.  In  competitive 
production  there  is  commonly  a  great  deal  of  waste, 
both  of  effort  and  material.  This  is  evidenced  by  the 
fact  that  in  many  cases,  upon  the  formation  of  a 
monopoly,  several  of  the  former  competing  plants 
have  been  shut  down  without  any  lessening  of  the 
supply  of  the  product.  Before  the  formation  of  the 
monopoly  organization  most  of  the  factories  had  been 
working  at  somewhat  less  than  their  capacity.  When 
the  monopoly  was  formed  all  the  factories  actually 
engaged  in  producing  were  working  at  full  capacity, 
while  the  less  efficient  were  shut  down. 

With  this  economy  of  production,  therefore,  it  is 
possible  for  the  monopoly  to  charge  lower  prices  and 
still  reap  a  greater  total  profit  than  that  gained  by  the 


MONOPOLY  AND   MONOPOLY   PRICE  157 

competing  firms.  It  does  not  follow,  however,  that 
the  monopoly  is  satisfied  with  such  a  gain.  If  it  can 
obtain  higher  profits  by  increasing  the  prices,  prices 
will  be  increased.  It  is  claimed  for  the  Standard  Oil 
Company  that  the  prices  charged  for  oil  under  its 
organization  are  less  than  formerly.  This  is  probably 
true.  But  since  the  formation  of  the  Standard  Oil 
Company  there  have  been  many  improvements  in  the 
method  of  manufacturing  fuel  and  illuminating  oil, 
and  the  probability  is,  that  if  competition  still  existed 
the  price  would  be  considerably  lower  than  that  charged 
by  the  Standard  Oil  Company. 

Factors  in  Determination  of  Monopoly  Price  —  The 
.problem  of  fixing  a  monopoly  price  is  not  simple. 
There  are  many  factors  to  be  considered.  The  nature 
of  the  demand  for  the  particular  commodity  must 
first  be  dealt  with.  If  the  demand  is  very  intense  it 
may  be  possible  to  fix  a  high  price.  Too  high  a  price, 
however,  will  in  any  case  reduce  demand.  The  opera- 
tors who  made  a  famous  "  corner  "  in  copper  discovered 
this  to  their  cost.  For  a  short  time  they  gained  ab- 
solute control  of  the  supply  of  copper,  and  at  once 
raised  the  price  to  such  a  level  that  the  consumers 
simply  ceased  to  consume  copper.  There  were  no 
buyers.  The  corner  collapsed  in  consequence,  for  the 
operators  could  not  control  the  necessary  capital  to 
hold  on  long  enough.  Had  they  been  satisfied  with 
a  more  moderate  price,  they  might  have  made  immense 
profits. 

Latent  Competition  —  A  very  high  price,  long  main- 
tained, encourages  competition.  It  is  true  that  if  the 
monopoly  is  sufficiently  strong  it  may  crush  such  com- 


158  AN  INTRODUCTION   TO   ECONOMICS 

petition,  but  only  at  the  expense  of  temporarily  re- 
ducing prices.  Therefore  what  may  be  termed  latent 
competition  has  an  influence  on  the  price  fixed  by  the 
monopoly. 

Elasticity  of  Demand  —  Apart  from  the  ever-present 
possibility  of  competition,  the  important  factor  to  be 
considered  is  the  nature  of  the  demand.  Some  com- 
modities have  a  very  wide  demand,  as,  for  example, 
those  which  are  of  everyday  use.  In  these  cases,  the 
greatest  profit  is  gained  through  the  widest  possible 
sale.  This  means  a  comparatively  low  price.  In  the 
case  of  the  manufacture  and  sale  of  soap  a  very  high 
price  will  cause  a  large  falling  off  in  sales.  To  sell 
soap  for,  say,  a  dollar  a  cake,  may  be  perfectly  possible 
if  the  monopoly  is  strong.  But  at  that  price  a  great 
many  possible  buyers  will  decide  to  do  without  soap 
and  regard  it  as  an  expensive  luxury.  Reduce  the 
price  to  twenty-five  cents  a  cake  and  the  sales  will 
multiply  much  more  than  fourfold.  If  we  assume, 
as  we  may  quite  safely,  that  the  increased  purchases 
amount  to  ten  times  those  at  the  higher  price  we  may 
estimate  the  profits  made.  Suppose  the  cost  of  a  cake 
of  soap  is  ten  cents  to  the  manufacturer,  inclusive  of 
all  distributing  costs.  The  profit  on  the  sale  of  one 
cake  is  ninety  cents,  at  the  price  of  one  dollar  a  cake. 
But  the  profits  made  by  selling  ten  cakes  at  twenty- 
five  cents  amount  to  one  dollar  and  a  half. 

It  must  also  be  noted  that  almost  invariably  the 
unit  cost  of  production  is  lessened  when  the  quantity 
produced  is  increased.  So  we  safely  reason  that  in 
the  case  of  the  reduced  sale  at  a  high  price  the  cost 
of  the  single  cake  of  soap  is  considerably  higher  than 


MONOPOLY  AND   MONOPOLY   PRICE  159 

when  the  larger  quantity  is  produced  for  the  wide 
market  at  twenty-five  cents. 

It  would  seem,  therefore,  that  in  such  cases  the 
tendency  of  a  scientifically  conducted  monopoly  would 
be  to  lower,  rather  than  to  increase  prices.  Few 
monopolies  are  so  scientifically  conducted,  however, 
and  even  where  prices  have  been  lowered,  as  we  have 
already  said,  the  prices  are  probably  not  as  low  as  they 
would  be  under  competition,  provided  the  production 
and  distribution  were  efficiently  managed.  In  other 
words,  the  facts  in  regard  to  monopoly  prices  support 
the  common  belief  that  monopoly  price  is  synonymous 
with  high  price. 

NOTE.  In  this  chapter  the  word  production,  as  distin- 
guished from  distribution,  is  used  in  the  ordinary  colloquial 
sense,  and  not  with  the  meaning  given  to  the  term  by  earlier 
definition.  Of  course,  speaking  accurately,  distribution  is  a 
form  of  production. 


CHAPTER  XIII 

THE   EVOLUTION   OF   MONEY 

One  of  the  most  difficult  facts  for  students  to  re- 
member in  connection  with  problems  of  exchange  is 
that  all  commerce  consists  merely  in  the  exchange  of 
goods  or  services  for  goods  or  services,  that  is,  in  the 
exchange  of  utilities.  We  speak  so  commonly  of  ex- 
changing money  for  goods  that  we  are  inclined  to  for- 
get that  money  is  merely  an  intermediary  in  the  matter 
of  exchange.  When  we  buy  a  pound  of  butter  at  a 
grocery  store  we  pay,  let  us  say,  sixty  cents.  The 
sixty  cents  are  then  used  by  the  grocer  to  buy,  possibly, 
a  pound  of  meat.  In  reality  what  has  happened  is 
that  there  has  been  an  exchange  of  butter  for  meat. 
Money  has  intervened  to  facilitate  the  transaction. 

In  order  to  obtain  a  clear  idea  of  the  nature  of 
money  it  will  be  well  to  study  the  simple  transactions 
before  money  was  invented.  Every  schoolboy  has 
taken  part  in  such  transactions,  for  money,  as  a  rule, 
is  a  scarce  commodity  with  schoolboys,  although  ex- 
changes are  common  enough.  In  these  transactions 
it  is  perfectly  obvious  that  the  exchange  is  one  of  goods 
alone,  with  no  intermediary.  A  knife  is  traded  for  a 
baseball  bat,  which  may  in  turn  be  traded  for  a  bird's 
nest  with  a  few  eggs  in  it,  or  for  a  supply  of  foreign 
stamps  or  some  such  article.  The  problems  to  be  solved 
are  comparatively  simple  as  the  number  of  exchange- 
160 


THE   EVOLUTION   OF  MONEY  161 

able  commodities  is  small.  In  this  respect  the  school- 
boy's commerce  is  not  unlike  that  of  primitive  man. 
In  primitive  times  few  articles  were  produced  which 
were  subject  to  exchange,  and  hence  exchanges  could 
readily  take  place,  although  with  some  difficulty. 
This  difficulty  can  be  seen  in  a  modern  instance. 

Problems  of  Barter  Exchange  —  The  advertise- 
ment columns  of  almost  any  newspaper  will  show  that 
some  one  is  desirous  of  exchanging  an  automobile  for  a 
city  lot.  Let  us  suppose  that  some  individual,  whom 
we  will  call  John  Smith,  wishes  to  exchange  his  ma- 
chine for  a  city  lot.  He  must  first  find  some  other 
person  who  has  a  city  lot  which  he  wishes  to  get  rid 
of.  There  is  never  much  difficulty  in  finding  such  an 
individual.  But  it  is  not  every  lot-owner  who  will  be 
satisfactory.  He  must  not  only  be  willing  to  dispose 
of  his  lot,  but  he  must  want  an  automobile  in  exchange. 
This  reduces  the  number  of  lot-owners  who  can  deal 
with  John  Smith.  Still  further  the  city  lot  must  be 
one  which  Smith  considers  equal  to  or  greater  in  value 
than  his  automobile  and  the  owner  of  the  lot  must  be 
satisfied  with  Smith's  machine.  With  each  condition 
to  be  satisfied  there  is  a  corresponding  reduction  in  the 
number  of  people  who  can  trade  with  Smith. 

Every  transaction  of  this  sort,  which  is  called  barter, 
is  subject  to  all  the  difficulties  mentioned.  To  carry 
out  our  modern  commerce  on  this  basis  is  obviously 
impossible.  Even  in  the  cases  advertised  in  the  news- 
papers, the  probability  is  that  when  the  settlement 
is  arrived  at,  there  is  a  balance  in  money  paid  by  one 
or  the  other  of  the  parties.  Now,  when  money  did  not 
exist,  the  exchange  had  to  be  kept  to  the  two  articles 


162  AN   INTRODUCTION   TO   ECONOMICS 

and  to  them  alone.  Suppose  an  Indian  makes  a 
specialty  of  producing  arrowheads.  He  must  exchange 
most  of  those  he  makes  for  food  or  clothing  or  shelter. 
Probably  he  takes  in  exchange  some  furs  from  animals 
caught  by  the  hunter,  who  desires  a  fresh  supply  of 
arrowheads.  It  is  quite  conceivable,  however,  that 
the  arrow  maker  has  sufficient  furs  for  his  needs  and 
wants  something  else,  say  a  new  supply  of  dried  buffalo- 
meat.  If  the  hunter  cannot  offer  this  meat,  the  ex- 
change will  not  take  place.  This  leaves  both  hunter  and 
arrow  maker  unsatisfied.  Obviously,  what  is  required 
is  some  commodity  which  is  desired  by  every  one. 

Cattle  Used  as  Money  —  In  primitive  times  this 
one  commodity  existed,  just  as  it  does  to-day,  although 
it  is  not  the  same  commodity.  Food  was  wanted  by 
all,  and  any  one  who  possessed  a  store  greater  than  he 
needed  for  his  own  use  could  always  exchange  some  of 
his  surplus  for  other  articles.  The  form  which  this 
commodity  took  was  usually  the  living  cattle.  Prices 
were  made  in  terms  of  head  of  cattle.  To  show  how 
intimately  the  cattle  form  of  money  is  connected  with 
our  earlier  stages  of  development,  it  is  sufficient  to 
consider  the  etymology  of  some  of  our  money  terms. 
The  word  "  cattle,"  for  example,  is  derived  from  the 
Latin,  caput,  a  head.  The  word  "chattel"  is  of 
similar  origin,  and  so  is  the  term  "capital"  which  is  so 
closely  associated  in  common  language  with  money. 
Again  the  Latin  word  for  a  flock  or  herd  is  pecus,  from 
which  is  derived  the  Latin  for  money,  pecunia. 

Another  word  which  commonly  denotes  a  payment 
of  money  is  the  word  "  fee,"  which  is  derived  from  the 
Anglo-Saxon  feoh,  meaning  either  cattle  or  money. 


THE   EVOLUTION   OF   MONEY  163 

Other  etymological  illustrations  might  be  given  from 
other  languages,  all  pointing  to  the  same  elementary 
fact,  but  the  above  will  be  sufficient. 

Other  Forms  of  Money  —  Apart  from  articles  of 
food,  those  which  are  desirable  for  purposes  of  cloth- 
ing or  ornament  have  been  used  as  money.  In  the 
early  years  of  the  colonization  of  America,  skins  were 
commonly  used  for  the  purpose  of  exchange,  just  as 
they  were,  apparently,  among  the  Israelites.  The 
well-known  quotation  from  Job,  skin  for  skin,  yea,  all 
that  a  man  hath  will  he  give  for  his  life,  seems  to  indi- 
cate that  skins  were  used  in  facilitating  exchange.  The 
American  Indians  used  strings  of  beads,  or  wampum 
belts,  as  money.  The  list  of  articles  which  have  been 
so  used  is  almost  inexhaustible,  including  feathers, 
furs,  oil,  fruits,  shells,  grain,  and  so  forth. 

All  these  different  articles  were  not  uniformly  satis- 
factory for  the  purpose  of  exchange.  Each  involved 
certain  difficulties,  and  we  can  best  appreciate  these 
difficulties  by  enumerating  the  qualities  which  are 
necessary  for  a  good  money  material. 

The  Qualities  Desirable  in  a  Money  Material, 
i.  Value  in  Use  —  Of  absolute  importance  is  the 
necessity  that  such  money  material  should  have  a 
value  in  use,  apart  from  its  value  as  a  means  of  exchange 
or  a  measure  of  value.  All  the  articles  named  above 
possess  this  quality.  Cattle,  grain,  oil  are  useful  for 
food;  furs  and  skins,  for  clothing;  beads,  shells, 
feathers,  for  ornament.  This  quality  is  essential,  but 
there  are  many  forms  of  goods  which,  although  they 
possess  the  quality  of  satisfying  some  desire,  are  not 
fit  for  purposes  of  exchange. 


164  AN  INTRODUCTION   TO   ECONOMICS 

2.  Universal   Acceptability  —  The   second   quality   is 
that  of  universal  acceptability.     It  is  not  sufficient  for 
one  or  two  persons  to  desire  the  article.     It  must  be 
desired  by  every  one.     If  a  professor  of  geology  were 
to  write  an  article  for  a  geological  magazine  and  the 
editor  offered  him,  in  payment,  an  extremely  rare  fossil, 
it  is  probable  that  the  geologist  would  willingly  accept 
it.     But   if   that   professor   offered   the   fossil    to    the 
plumber  for  repairing  the  plumbing  in  his  bathroom, 
there  is  little  doubt  as  to  the  attitude  the  plumber 
would  take.     In  primitive  times  the  payment  would 
be  made  in  one  of  the  articles  we  have  named,  or  some- 
thing similar. 

3.  Divisibility  —  All  exchanges  are  not  of  the  same 
magnitude,    however.     It   might    still    be   possible    to 
use  a  herd  of  cows  in  payment  for  part  of  a  ranch,  for 
instance.     But  if  cattle  were  the  only  money  substance 
it  would  be  very  difficult  to  buy  a  box  of  candy,  or  to 
pay  for  a  street-car  ride.     These  are  extreme  instances, 
of  course,  but  the  principle  is  important.     To  be  really 
satisfactory,  the  money  commodity  should  be  capable 
of  being  divided  into  small  portions  for  small  exchanges. 
It  must,  therefore,  possess  the  quality  of  divisibility. 

There  are  many  substances  which  possess  all  of  the 
above  attributes  and  yet  which  lack  another  necessity 
of  a  good  money  commodity.  In  regard  to  the  last- 
mentioned  quality  —  divisibility  —  there  are  difficulties 
with  certain  easily  divisible  objects.  Precious  stones 
have  sometimes  been  used  as  money,  and  every  one 
knows  that  precious  stones  are  divisible.  But  in 
dividing  a  stone  we  lose  some  of  its  value.  If  we  take 
a  ten  carat  diamond,  for  example,  and  divide  it  into 


THE   EVOLUTION   OF  MONEY  165 

two  diamonds  of  five  carats  each,  the  value  of  the  two 
diamonds  together  will  not  equal  that  of  the  original 
stone  from  which  they  were  cut.  Size  itself  is  an  ele- 
ment in  the  value  of  the  precious  stone.  In  order  to 
be  satisfactory,  therefore,  the  commodity  should  not 
only  be  divisible,  but  should  not  suffer  any  loss  in  value 
by  being  divided. 

4.  Homogeneity  —  Another  difficulty  arises  in  con- 
nection with  the  use  of  certain  substances  which  can 
be  divided.  In  the  case  of  skin-money,  for  example, 
it  is  quite  possible  to  cut  the  skin  into  two  parts,  each 
of  which  weighs  half  of  the  original  skin.  But  the 
value  of  one  part  is  not  the  same  as  that  of  another. 
The  half  which  contains  the  head  may  be  used  as  an 
ornament;  at  least,  some  people  consider  the  stuffed 
head  of  an  animal  an  ornament.  The  other  half  is 
practically  worthless.  Again,  in  the  case  of  dead  cattle, 
if  the  animal  is  so  divided  that  one  part  containing 
most  of  the  bones  weighs  as  much  as  the  other  part 
containing  most  of  the  meat,  the  values  of  the  two 
parts  are  by  no  means  equal.  This  is  also  the  case 
with  the  living  cattle.  A  buyer  will  try  to  pay  with 
the  poorest  of  his  herds  and  a  seller  will  stipulate  for 
the  fattest  of  the  animals.  Indeed  the  laws  of  old 
Egypt  expressly  stated  that  thin  cattle  would  not  be 
accepted  in  payment  of  taxes.  Government,  even  in 
those  early  times,  knew  enough  not  to  accept  cheap 
money.  From  this  difficulty  we  see  that  another 
quality  is  necessary  in  the  material  to  be  used  as  money. 
It  must  be  homogeneous.  That  is,  it  must  lose  nothing 
of  its  characteristics  by  being  divided  into  small  por- 
tions. One  part  by  weight  should  be  exactly  equal  to 


166  AN  INTRODUCTION   TO   ECONOMICS 

another  part  of  the  same  weight.  And  not  only  so, 
but  when  a  piece  of  the  material  is  divided  into  two 
equal  parts,  the  sum  of  the  values  of  the  parts  should 
equal  the  value  of  the  original  piece.  Precious  stones 
are  undoubtedly  homogeneous.  A  diamond  is  simply 
a  piece  of  crystalline  carbon  and  it  does  not  cease  to  be 
so  when  cut  into  smaller  pieces.  But  as  size  is  an  ele- 
ment in  its  value  it  cannot  be  used  satisfactorily. 

5.  Portability  —  The  next  quality  which  we  find  to 
be  desirable   is    that   of   portability.     Some   forms   of 
goods  which  answer  satisfactorily  all  of  the  require- 
ments enumerated  so  far  are  unsatisfactory   in   that 
they  can  only  be  transported  at  comparatively  great 
expense.     It  is  true  that  cattle  may  be  regarded  as 
portable  in  that  they  carry  themselves,  but  they  do  not 
do  so  without  expense.     The  further  they  have  to  be 
transported  the  greater  is  the  cost  in  time  for  their 
care,   and  in  food  for  their  support  on  the  journey. 
Hence  if  the  cattle  are  to  be  used  as  a  payment  for 
goods  bought  from  some  person  who  lives  a  considerable 
distance  away,  the  expense  of  transportation  may  be 
so  great  as  to  make  the  purchase  not  worth  while. 

Even  some  of  the  early  forms  of  metallic  money  were 
not  free  from  this  defect.  At  the  present  time,  as  we 
shall  see  in  a  later  chapter,  gold  itself  is  expensive  to 
transport,  and  the  cost  of  transportation  has  a  material 
influence  upon  the  value  of  the  metal. 

6.  Durability  —  If  we  suppose  that  a  herd  of  cattle 
has  been  accepted  in  payment  of  a  certain  purchase  and 
has  to  be  transported  for  a  distance  before  reaching  the 
seller  of  the  goods,  there  may  be  more  difficulties  en- 
countered than  even  the  expense  of  feeding  and  caring 


THE   EVOLUTION   OF  MONEY  167 

for  the  cattle  on  the  journey.  If  they  have  to  traverse 
a  country  which  has  only  sparse  pasture  or  in  which 
water  is  lacking,  it  is  quite  possible  that  the  cattle  will 
deteriorate  very  greatly  during  the  journey.  Some 
will  die  and  will  be  worth  practically  nothing  even  if 
the  carcasses  can  be  carried  to  the  end  of  the  journey. 
Again,  if  eggs  happen  to  be  the  money  material  and 
any  length  of  time  elapses  between  the  bargain  and 
the  payment,  it  is  quite  within  the  bounds  of  possi- 
bility that  the  eggs  will  lose  in  flavor  before  they  reach 
their  final  owner.  A  quality  to  be  desired  in  our  money 
commodity,  therefore,  is  that  of  durability  without  loss 
of  value. 

There  is  no  commodity  which  is  absolutely  durable, 
in  the  sense  that  it  cannot  wear  out.  But  there  are 
undoubted  degrees  of  durability,  and  if  one  commod- 
ity satisfies  most  of  the  requirements  for  use  as  money 
and  is  also  fairly  durable  in  use,  it  is  so  much  the 
more  to  be  desired. 

7.  Stability  —  Then  there  arises  the  question  of  the 
stability  of  value  of  the  commodity.  We  have  already 
shown  some  of  the  influences  which  are  exerted  in  the 
determination  of  value,  and  of  those  influences  one  of 
the  most  important  is  that  of  supply.  Other  things 
being  equal,  we  may  say  that  the  greater  the  supply 
the  less  is  the  value  of  the  commodity.  Now,  if  the 
supply  of  a  commodity  varies  within  wide  limits,  the 
probability  is  that  its  value  will  also  vary.  A  money 
commodity  is  used  not  only  as  a  means  of  exchange, 
but  also  as  a  measure  of  value.  For  the  sake  of  sim- 
plicity we  are  accustomed  to  estimate  the  values  of 
different  goods  according  to  the  amount  of  the  money 


168  AN  INTRODUCTION   TO   ECONOMICS 

commodity  for  which  they  will  be  exchanged.  If  the 
money  commodity  is  constantly  fluctuating  in  value 
itself,  it  becomes  almost  useless  as  a  measure  of  value. 
Suppose  we  use  wheat  as  the  money  material.  One 
day  the  worth  of  a  bushel  of  wheat  may  be  represented 
as  a  couple  of  pounds  of  butter  or  five  pounds  of  coffee 
or  half  a  dozen  watermelons.  Now  if  we  say  that  two 
pounds  of  butter  are  worth  a  bushel  of  wheat  we  are 
stating  the  price  of  butter  in  terms  of  wheat.  If  the 
value  of  wheat,  owing  to  a  sudden  increase  in  the  avail- 
able supply,  suddenly  falls,  the  exchanges  will  not 
take  place  in  the  same  ratio.  Hence  two  pounds  of 
butter  will  no  longer  be  equal  in  value  to  a  bushel  of 
wheat;  they  will  be  greater.  Similarly  the  values 
of  the  coffee  and  melons  will  be  altered  when  stated 
in  terms  of  wheat.  Hence  it  is  always  advisable  to 
choose  a  commodity  which  does  not  vary  much  in 
value  from  time  to  time. 

8.  Cognizability  —  The  final  quality  which  we  shall 
consider  as  an  element  in  the  money  material  is  that 
of  cognizability.  The  money  should  be  easily  recog- 
nized for  what  it  is  without  any  undue  investigation 
into  its  character.  A  little  thought  on  the  conditions 
of  our  present  money  supply  will  show  the  reasonable- 
ness of  this  requirement.  We  become  at  once  sus- 
picious of  any  money  with  which  we  are  not  familiar. 
The  familiar  money  we  know  and  can  recognize ;  the 
unfamiliar  we  must  scrutinize  carefully.  There  are 
parts  of  the  United  States  where  the  use  of  coined 
money  is  much  greater  than  in  others  where  paper 
equivalents  are  more  frequently  seen.  The  paper  is 
scrutinized  more  carefully  in  those  districts  where  its 


THE   EVOLUTION   OF  MONEY  169 

use  is  not  so  frequent  than  in  those  where  it  is  common, 
and  vice  versa. 

Before  we  consider  what  is  the  basis  of  the  modern 
money  materials  it  will  be  well  to  sum  up  in  tabulated 
form  the  requirements  of  a  perfect  money  material. 

1.  Commodity  Value 

2.  Acceptability 

3.  Divisibility 

4.  Homogeneity 

5.  Portability 

6.  Durability 

7.  Stability 

8.  Cognizability 

Metals  as  Money  —  Of  all  substances  which  have 
been  used  at  different  times  as  money  the  metals 
possess  the  above  attributes  in  the  greatest  degree. 
At  all  times  the  metals  have  been  desired  for  their  own 
value  apart  from  any  uses  as  measures  of  value  or  means 
of  exchange.  At  first,  probably,  they  were  used  as 
ornament,  and  later  on  came  their  use  in  industry  and 
for  weapons  of  war.  There  was  hardly  ever  a  time 
when  metals  were  not  generally  acceptable.  They 
possess  the  quality  of  divisibility,  without  loss  of  value, 
in  a  high  degree.  A  piece  of  copper  which  weighs  a 
pound  is  of  the  same  value  as  two  pieces  which  weigh 
half  a  pound  each.  And  one  piece  of  copper  is  exactly 
the  same  as  another  piece  of  the  same  weight.  It  is 
homogeneous.  The  metals  are  portable  also,  with 
comparatively  small  expense.  It  is  true  that  to  use 
the  older  Greek  iron  money  for  modern  payments  and 
with  our  present  valuation  of  iron,  would  involve  high 


170  AN  INTRODUCTION   TO   ECONOMICS 

costs  for  transportation  of  any  considerable  sum. 
That  would  not  hold  good  in  the  days  of  iron  money, 
for  its  value  was  much  greater  then  than  now.  The 
metals  are  exceptionally  durable  also,  although  there 
are,  of  course,  variations  in  their  degrees  of  durability. 
Iron  money  is  not  so  durable  as  copper  if  continually 
exposed  to  the  elements.  Copper  on  the  other  hand 
will  wear  out  by  friction  quicker  than  iron.  Gold  and 
silver  also  are  soft  metals  and  liable  to  lose  by  constant 
use  some  of  their  weight.  No  commodity  is  per- 
manently durable,  however,  and  consequently  all  we 
can  ask  is  a  comparatively  high  degree  of  durability, 
and  that  is  possessed  generally  by  the  metals.  Again 
it  may  be  said  that  no  material  is  absolutely  stable  in 
value.  But  the  fluctuations  of  metals  are,  taking 
everything  into  consideration,  less  than  most  other 
materials.  Finally,  especially  in  primitive  times,  the 
metals  were  easily  recognized. 

Remedies  for  Defects  in  Metallic  Money  —  It  is  in 
the  last  three  qualities  that  the  metals  are  least  satis- 
factory, especially  the  common  money  metals,  gold, 
silver,  and  copper.  But  much  can  be  done  to  remedy 
their  defects  in  these  respects.  In  regard  to  dura- 
bility, for  example,  while  it  is  true  that  gold  is  par- 
ticularly liable,  when  pure,  to  loss  irom  friction  in 
use,  it  can  be  made  much  less  so  by  the  admixture  of  a 
small  proportion  of  cheaper  metal,  without  thereby 
losing  much  in  value.  The  alloys  of  gold  are  much 
harder  and  so  less  liable  to  loss  from  wear  than  is 
pure  gold.  The  same  is  true  of  the  other  metals. 
Hence  we  do  not,  in  our  coinage,  use  pure  gold  or  pure 
copper. 


THE   EVOLUTION   OF  MONEY  171 

Coined  Money  —  The  greatest  advantage  of  our 
modern  coined  money  is,  however,  its  cognizability. 
There  are  many  cheap  imitations  of  gold  and  of  silver 
which  might  easily  pass  with  the  unsophisticated  for 
the  real  article.  Even  in  America  people  have  been 
known  to  accept  "  gold  bricks  "  in  the  belief  that  they 
were  pure  gold.  This  fact  of  the  possible  imitation 
and  also  the  variations  in  the  amount  of  "  base  "  metal 
used  in  the  alloys  have  made  it  necessary  that  there 
should  be  some  indication,  on  the  metal  itself,  of  the 
nature  of  its  purity. 

The  development  of  the  imprinting  of  some  stamp 
on  the  surface  of  a  piece  of  metal,  by  some  person 
whose  reputation  was  good,  has  resulted  in  the  evo- 
lution of  the  modern  coin.  Originally,  probably  some 
king  or  duke  or  other  person  in  authority  placed  his 
seal  on  the  flat  piece  of  metal,  thereby  indicating 
that  it  was  of  standard  purity.  The  seal  would  not, 
at  first,  cover  the  entire  surface  of  the  piece  of  metal, 
and  partly  through  wear  and  tear,  and  partly  through 
the  efforts  of  early  economically  minded  merchants, 
the  surplus  metal  outside  the  seal  would  tend  to  be 
gradually  removed,  and  before  long  the  shape  would 
approximate  to  that  of  the  seal.  In  order  to  avoid  such 
loss  by  clipping,  at  any  rate,  the  habit  grew  of  making 
the  metal  the  same  size  and  shape  as  the  seal,  and  as  the 
ultimate  shape  of  any  flat  piece  of  metal,  constantly 
used,  tends  to  be  circular,  so  these  pieces  of  metal  came 
to  be  made  circular.  In  order  to  prevent  filing  of  the 
edges  the  latter  were  "  milled  "  or  some  design  was 
stamped  upon  them  so  that  any  attempts  at  filing  would 
be  obvious. 


172  AN  INTRODUCTION   TO   ECONOMICS 

1  Definition  of  a  Coin  —  Now  all  this  work  placed 
on  the  metal  was  made  necessary  only  by  the  desire  to 
make  it  cognizable  for  what  it  purported  to  be,  that 
is,  a  piece  of  metal  of  a  standard  weight  and  fineness. 
And  that  is  all  that  a  coin  is.  To  define  a  coin,  then, 
we  may  say  that  it  is  a  piece  of  metal  upon  whose 
surfaces  have  been  placed  stamps  or  designs  by  some 
one  in  authority,  the  designs  indicating  that  the  metal 
is  of  a  certain  weight  and  purity.  Because  it  is  shaped 
in  this  way  it  does  not  lose  its  characteristics  as  a  com- 
modity. It  is  essential  that  these  should  still  exist 
in  order  to  satisfy  the  requirements  which  we  have 
studied  in  the  earlier  part  of  this  chapter. 

Debasement  of  Coinage  —  It  is  obviously  of  great 
importance  that  the  stamp  placed  upon  the  coin  should 
be  placed  by  a  person  whose  reputation  is  good.  No 
one  would  place  any  reliance  upon  the  certificate  of 
value  issued  by  an  unknown  merchant.  It  might  be 
good,  but,  on  the  other  hand,  it  might  not.  In  feudal 
times  the  right  of  coinage  rested  in  the  hands  of  the 
feudal  barons,  except  when  the  king  retained  the  sole 
right  himself.  Unfortunately  for  the  subjects,  the 
king  did  not  always  justify  their  faith  in  his  certificates. 
Just  as  it  is  possible  for  a  commercial  company  to 
cheat  the  public  by  selling  adulterated  goods,  at  least 
for  a  certain  time,  so  was  it  possible  for  kings  to  adulter- 
ate their  money,  by  increasing  the  proportion  of  base 
metal  in  the  coin.  There  would  appear  to  be  a  certain 
advantage  to  the  king  in  so  doing,  in  that  he  seemed  to 
be  getting  a  coin  which  was  of  greater  value  as  a  coin 
than  as  metal.  But  the  advantage  was  only  temporary, 
and  its  consequences  were  serious  to  the  people  who 


THE    EVOLUTION   OF   MONEY  173 

were  compelled  to  use  the  coinage,  especially  if  they 
were  poor.  It  soon  becomes  known  if  the  coins  are 
being  depreciated,  and  the  more  intelligent  merchants 
then  realize  that  the  commodity  value  has  been  re- 
duced and  hence  the  ratio  at  which  they  will  exchange 
their  goods  for  this  money  decreases.  If  a  certain  coin 
of  full  fineness  is  worth  a  bushel  of  wheat,  then  the 
coin  which  is  not  of  full  fineness  will  not  be  accepted 
in  payment  of  a  whole  bushel.  If  the  coin  is  suf- 
ficiently depreciated,  it  will  buy  only  half  a  bushel. 
But  as  the  name  of  the  coin,  whether  it  be  crown,  noble, 
pound,  or  dollar,  remains  the  same,  the  number  of  coins 
to  be  paid  for  the  bushel  of  wheat  is  now  two.  In 
other  words,  the  price  of  wheat  has  been  doubled. 
And  the  case  is  similar  with  other  commodities. 

Effects  of  Depreciated  Coinage  —  The  effect  of  a 
depreciation  in  the  coinage,  therefore,  is  at  first  a  rise 
in  prices.  But  if  the  amount  of  depreciation  is  not 
the  same  with  each  coin,  the  tendency  arises  for  the 
stamp  on  the  coin  to  be  disregarded  entirely  and  the 
coin  is  accepted  by  merchants  only  upon  an  assay,  and 
then  by  weight  of  the  pure  metal  calculated  according 
to  the  results  of  the  assay.  Even  the  government 
itself  sometimes  refused  to  accept  at  face  value  for 
taxes  the  coinage  in  circulation.  At  one  period  of 
English  history,  when  the  coinage  was  considerably 
debased,  the  face  value  of  the  coins  was  ignored  by  the 
government  tax  collectors.  When  the  sheriffs  brought 
to  the  exchequer  the  sacks  of  coin  in  payment  of  the 
tax  levies  on  their  districts,  the  actual  commodity 
value  of  the  coinage  was  tested  by  an  assay  of  a  sample 
of  the  coins.  Part  of  the  sacks  of  coin  was  tested  and 


174  AN  INTRODUCTION   TO   ECONOMICS 

the  whole  of  the  sacks  averaged  according  to  the  results 
of  the  assay.  The  bulk  was  then  weighed  and  the 
taxes  paid  by  the  weight  of  gold  contained  in  the  sacks. 
The  merchants  who  received  payments  in  large 
amounts,  received  payment  by  weight  and  not  by 
"  tale,"  that  is,  by  nominal  value.  The  poorer  classes 
were  compelled  to  receive  their  payments  of  wages 
by  tale  and,  as  the  depreciation  caused  increase  of 
prices,  the  actual  amount  of  goods  that  they  received 
as  a  return  for  their  services  (what  we  shall  later  term 
"  real  wages  ")  was  very  much  reduced. 


CHAPTER  XIV 

SOME   MONEY   PROBLEMS 

Seigniorage  —  The  coinage  of  money  is  not  con- 
ducted without  expense.  In  the  feudal  days,  when  the 
right  of  coinage  was  confined  to  the  lord  of  the  manor, 
or  the  seignior,  it  was  customary  for  the  latter  to 
charge  a  certain  amount  to  pay  for  the  cost  of  turning 
the  metal  into  coins.  This  charge,  which  varied  ac- 
cording to  the  greed  or  generosity  of  the  seignior,  ranged 
from  a  bare  charge  sufficient  to  cover  expenses  to  as 
much  as  the  people  could  be  forced  to  pay.  Such  a 
charge  is  known  as  seigniorage.  At  the  present  time 
in  some  countries  it  is  still  the  custom  to  charge  seignior- 
age. In  others  the  government  bears  the  whole  of  the 
cost.  The  latter  is  the  case  in  the  United  States.  In 
cities  where  no  mint  exists,  it  is  customary,  however, 
to  charge  a  small  percentage  of  the  value  of  the  gold  to 
cover  the  cost  of  assaying  the  gold.  In  England  one 
ounce  of  gold  makes  coinage  to  the  extent  of  £3-17-10^. 
The  Bank  of  England,  which  supplies  all  the  gold  to 
the  mint,  is  allowed  to  buy  gold  at  £3-17-9.  The 
difference  of  three  cents  (one  and  one-half  pence)  an 
ounce  compensates  the  bank  for  the  loss  of  interest  on 
its  expenditure  for  gold,  for  a  certain  time  must  elapse 
before  the  gold  coin  can  be  turned  out  from  the  mint. 

Gresham's  Law  —  In  the  last  chapter  some  of  the 
difficulties  in  connection  with  a  depreciation  of  the 
175 


176  AN   INTRODUCTION   TO   ECONOMICS 

coinage  were  indicated.  In  order  to  avoid  these  dif- 
ficulties it  is  advisable  always  to  keep  the  money  at 
proper  standard  value ;  that  is,  the  value  of  the  metal 
as  a  commodity  and  as  coin  should  be  kept  equal.  Now 
in  reforming  the  coinage  some  special  difficulties  al- 
ways arise.  One  of  these  is  of  great  importance,  for 
it  gives'  us  one  of  the  fundamental  laws  of  money. 

If  there  are  two  kinds  of  coinage  in  existence  of 
different  commodity  value,  but  of  the  same  nominal 
value,  we  shall  always  find  that  there  is  a  tendency 
for  the  better  class  of  money,  the  class  which  is  of 
equal  value  as  commodity  and  as  coin,  to  go  out  of 
circulation.  The  reason  for  this  is  not  difficult  to  ap- 
preciate. Suppose  a  merchant  has  a  supply  of  what 
we  may  call  "  good  "  money  on  hand,  coined  into  the 
same  denominations  as  the  bad  money.  He  will  be 
inclined  to  charge  for  his  goods  on  the  basis  of  the 
value  of  the  depreciated  coinage.  If  his  good  coins 
contain  twenty  per  cent  more  pure  gold  than  the  bad 
ones,  he  will  be  inclined  to  sell  the  good  coins  to  the 
goldsmiths  as  bullion,  receiving  in  payment  the  bad 
coins.  He  will,  of  course,  receive  more  money,  nom- 
inally, than  the  coin  value  of  the  money  he  has  sold. 
To  put  it  in  concrete  figures,  suppose  he  has  one  thou- 
sand dollars,  nominally,  in  good  money.  This  money 
he  sells  for  its  gold  value  to"  a  goldsmith.  But  prices 
have  gone  up  in  terms  of  the  bad  money.  He  sells,  as 
far  as  the  goldsmith  is  concerned,  not  coins,  but  gold. 
The  gold  price,  like  anything  else,  stated  in  terms  of 
the  depreciated  currency,  has  gone  up.  Hence  the 
merchant  receives  twelve  hundred  dollars  in  the  cheaper 
coinage  for  the  gold  coins  he  has  sold  to  the  goldsmith. 


SOME   MONEY   PROBLEMS  177 

As  practically  every  merchant  is  doing  the  same 
thing,  in  a  comparatively  short  time  there  will  be  none 
of  the  good  coinage  left  and  all  that  remains  in  circula- 
tion will  be  the  cheap  money.  Sir  Thomas  Gresham, 
who  became  Master  of  the  Mint  when  Queen  Elizabeth 
was  reforming  the  debased  coinage  instituted  by  her 
venerable  father,  formulated  this  argument  into  what 
is  now  known  as  Gresham's  Law.  Stated  briefly  this 
law  is  that  "  Bad  money  drives  out  good."  In  other 
words,  where  there  are  two  forms  of  money  in  circula- 
tion, the  commodity  value  of  one  being  greater  than 
that  of  the  other,  there  will  be  a  tendency  for  the  coin- 
age of  higher  commodity  value  to  go  out  of  circulation, 
leaving  the  cheaper  to  be  used  in  trade. 

Subsidiary  Coinage.  Token  Money  —  So  far  we 
have  spoken  as  if  the  only  coinage  in  circulation  in 
any  country  consisted  of  one  metal.  We  know,  how- 
ever, that  there  is  more  than  one  metal  in  circulation 
in  the  United  States.  We  have  gold  coins,  silver, 
nickel,  and  bronze.  If  the  statement  contained  in 
Gresham's  Law  be  true,  how  is  it  that  the  gold  has  not 
been  driven  out  of  circulation  by  the  silver  and  the 
silver  in  turn  by  the  nickel  ? 

The  reason  is  that  we  have,  in  reality,  only  one 
form  of  standard  money.  Consider  for  a  moment  the 
difficulties  that  would  arise  if  all  payments  had  to  be 
made  in  gold.  Wrhat  sort  of  coin  would  we  have  to 
use  to  pay  for  a  street-car  ride  ?  It  would  be  so  small 
as  almost  to  require  a  microscope  to  see  it.  Gold,  we 
have  already  noted,  is  divisible ;  but  for  very  small  pur- 
chases, considering  the  value  of  gold,  gold  is  not  suit- 
able. Hence  there  must  be  some  substitute.  We 


178  AN   INTRODUCTION   TO   ECONOMICS 

substitute  silver  and  nickel  for  the  purpose  of  making 
small  payments.  There  is  no  relation  between  the 
value  of  the  silver  coins  as  silver  and  their  value  as 
coins.  They  obtain  their  value  as  coins  from  an  en- 
tirely different  source.  According  to  our  currency 
laws  gold  may  be  used  in  payments  to  any  extent.  If 
we  offer  coined  gold  eagles  in  payment  of  a  debt  within 
the  country  and  the  creditor  refuses  to  accept  them, 
the  debt  is  canceled.  But  this  is  not  true  of  the  sub- 
sidiary silver  and  nickel  coins.  They  are  only  to  be 
used  for  payments  of  ten  dollars  or  less.  The  creditor, 
for  a  sum  greater  than  ten  dollars,  may  refuse  payment 
in  silver  coins. 

How,  then,  do  the  subsidiary  coins  retain  their  face 
value  in  the  smaller  purchases?  The  United  States 
Treasury  is  ready  at  any  time  to  redeem  silver  and 
nickel  and  bronze  coins,  provided  they  are  offered  in 
amounts  not  less  than  twenty  dollars'  face  value,  in 
gold.  In  reality,  such  subsidiary  coins  are  not  true 
money.  They  are  tokens  of  true  money  and  hence 
are  commonly  known  as  token  money.  Their  function 
is  to  facilitate  small  payments,  and  the  law  definitely 
restricts  their  use  as  money  to  the  payment  of  small 
sums.  Of  course,  there  is  nothing  to  prevent  any  one 
accepting  subsidiary  coins  in  payment  of  any  sum  if 
he  so  wishes,  but  the  law  does  not  compel  him  to  ac- 
cept them  for  sums  over  a  certain  amount. 

Bimetallism  —  This  brings  us  to  a  subject  which 
has  caused  an  immense  amount  of  discussion  in  almost 
every  country.  Is  it  possible  or  desirable  to  use  at 
one  and  the  same  time  two  different  metals  as  standard 
money  ?  It  is  beyond  the  scope  of  the  present  book  to 


SOME   MONEY   PROBLEMS  179 

consider  this  rather  difficult  question  in  detail.  But 
it  is  worth  while  to  point  out  the  probable  results  of 
such  an  attempt,  particularly  as  most  experience  shows 
that  these  probable  results  become  actual  in  practice. 

Suppose  we  use  the  two  metals,  silver  and  gold,  and 
coin  them  into  standard  money.  If,  at  the  time  of  the 
coinage,  an  ounce  of  gold  is  worth  fifteen  ounces  of 
silver,  then  the  silver  dollar  must  contain  fifteen  times 
as  much  metal,  by  weight,  as  the  gold  dollar.  Every- 
thing will  be  satisfactory  so  long  as  the  fluctuations 
in  the  value  of  the  two  metals,  as  compared  with  general 
commodities,  follow  one  another  in  the  same  ratio. 
That  is,  there  will  be  no  difficulty  if  a  rise  of  five  per 
cent  in  the  value  of  gold  is  accompanied  by  a  rise  of 
five  per  cent  in  the  value  of  silver.  But  that  is  very 
seldom  the  case.  The  conditions  which  affect  the 
value  of  gold  have  no  direct  bearing  upon  those  which 
affect  the  value  of  silver.  Hence  before  long  the  ratio 
of  exchange  of  the  two  metals  as  commodities  will 
change  from  fifteen  to  one,  to,  let  us  say,  sixteen  to  one. 
In  this  case  gold  has  evidently  become  more  valuable. 
Gresham's  Law  will  at  once  begin  to  operate  to  drive 
gold  out  of  circulation.  If  the  ratio  change  in  the 
other  direction,  then  silver  will  become  comparatively 
more  valuable  than  gold.  Gresham's  Law  will  then 
work  to  drive  silver  out  of  circulation  and  leave  the 
gold. 

Position  of  Silver  Dollars  —  Now  it  is  true  that  the 
silver  dollars  which  circulate  in  this  country  are  stand- 
ard money  as  far  as  the  law  is  concerned.  They  are 
legal  tender  for  any  amount.  As  a  matter  of  fact, 
however,  there  are  so  few  in  circulation,  comparatively, 


180  AN    INTRODUCTION   TO   ECONOMICS 

at  any  rate,  that  they  do  not  affect  'the  gold  coinage. 
The  principle  of  having  two  metals  both  standard  for 
coinage  purposes  is  known  as  bimetallism.  A  full 
discussion  of  the  subject,  however,  is  too  difficult  for 
an  elementary  work  like  the  present. 

United  States  Currency  —  There  are  other  forms  of 
money  which  must  be  considered,  however,  besides 
the  metallic  coinage.  At  the  present  time  the  currency 
of  the  United  States  consists,  besides  token  money, 
of  gold  and  silver,  gold  and  silver  certificates,  Treas- 
ury Notes,  Greenbacks,  National  Bank  Notes,  Federal 
Reserve  Notes,  Federal  Reserve  Bank  Notes,  and  a 
few  other  forms  which  need  not  be  enumerated.  All 
this  paper  money  has  an  important  place  in  the  cur- 
rency supply  of  the  country.  With  the  different 
forms  of  bank  notes  we  shall  be  concerned  later, 
when  the  banking  system  has  been  considered. 
In  the  meantime  it  must  be  noted  that  these  forms 
of  paper  money  all  depend  for  their  value  on  the 
possibility  of  their  redemption  in  standard  money. 
In  regard  to  the  greenbacks,  for  instance,  we  have  a 
definite  promise  of  the  government  to  pay  on  de- 
mand to  any  holder  of  a  note  the  sum  stated  on  that 
note  in  gold.  As  long  as  the  government  stands  ready 
to  fulfill  its  promise  there  is  no  difficulty  in  keeping  the 
greenbacks  up  to  par ;  that  is,  in  maintaining  the  face 
value  of  the  note  at  the  same  value  as  that  of  gold  of 
the  same  denomination.  The  same  is  true  of  the  bank 
notes.  Provision  is  made,  as  we  shall  see  later,  for 
redeeming  these  notes  in  gold  at  the  will  of  the  holder. 
These  notes  are  properly  termed  credit  money,  as  their 
value  is  based  on  the  credit  of  the  issuing  body,  whether 


SOME   MONEY   PROBLEMS  181 

government  or  bank,  or  the  belief  that  these  bodies 
will  fulfill  their  promises. 

Money  and  Price  —  We  are  now  ready  to  consider 
the  relation  between  money  and  prices.  In  an  earlier 
chapter  it  was  stated  that  price  is  merely  another  word 
for  value  in  terms  of  money.  Value  is  the  ratio  at 
which  one  commodity  exchanges  for  another.  Price 
is  the  ratio  at  which  a  commodity  exchanges  for  money. 
But  money  is  itself  a  commodity,  or  represents  a  com- 
modity. Hence  price  is  merely  a  suitable  term  for 
estimating  value. 

In  our  resume  of  the  qualities  necessary  for  a  good 
money  commodity  we  found  that  stability  of  value 
was  one  of  the  most  important.  Now  no  commodity 
is  absolutely  stable.  Money  is  perhaps  more  stable 
than  most  other  commodities,  but  it  fluctuates  con- 
siderably. The  value  of  gold,  for  instance,  will  depend 
to  a  very  large  extent  upon  the  supply  available  and 
the  demand  for  it.  The  demand  for  gold  is  not  simple, 
however.  It  is  at  least  twofold.  There  is  the  de- 
mand for  gold  for  use  in  the  arts.  Jewelers,  gold- 
smiths, and  dentists  require  a  certain  amount  of  gold 
for  their  business.  Gold  is  also  demanded  for  the 
purpose  of  making  coins.  The  more  gold  taken  for 
coinage,  the  less  there  is  available  for  the  jewelers 
and  dentists,  and  vice  versa.  Sudden  changes  in  the 
production  of  gold  naturally  affect  the  supply  and 
hence  the  value  also.  The  discovery  of  gold  in  Cali- 
fornia, Australia,  and  Alaska  all  affected  very  seri- 
ously the  value  of  gold.  What  influence  has  this 
upon  prices? 

In  discussing  this  question  it  must  be  remembered 


182  AN  INTRODUCTION   TO   ECONOMICS 

very  carefully  that  money  supply  is  not  the  only  ques- 
tion to  be  considered  in  the 'determination  of  the  price 
of  any  particular  commodity.  There  must  also  be 
taken  into  account  the  fluctuations  in  demand  and 
supply  of  the  different  commodities  and  all  the  other 
influences  which  help  to  determine  their  price.  In  the 
present  discussion,  therefore,  it  must  be  understood 
that  the  phrase  "  other  things  being  equal  "  is  of  the  ut- 
most importance. 

Relation  of  Gold  Supply  to  Prices  —  The  amount  of 
wheat  which  exchanges  for  five  dollars  in  gold  varies 
with  the  amount  of  wheat  and  the  amount  of  gold  in 
the  market.  Assuming  that  the  amount  of  wheat  and 
the  demand  for  it  are  unchanged,  then  the  effect  of  an 
increase  in  the  supply  of  gold  will  be  to  increase  the 
price  of  wheat.  The  increase  in  the  supply  of  gold 
means  a  fall  in  its  value.  Hence  five  dollars  in  gold 
is  not  worth  the  amount  of  wheat  for  which  it  formerly 
exchanged.  The  wheat  owner  will  therefore  demand 
more  gold  for  his  wheat.  In  other  words  the  price  of 
his  wheat  will  increase.  The  reverse  will  be  true  should 
the  supply  of  gold  decrease. 

The  fluctuations  in  the  supply  of  gold  are  very  con- 
siderable and,  if  we  depended  entirely  upon  gold  for 
our  currency,  we  should  find  a  much  greater  fluctua- 
tion in  prices  than  actually  is  due  to  currency  changes. 
As  we  have  seen,  we  have  supplemented  the  currency 
from  many  different  sources  and  as  some  of  these 
sources  are  elastic,  they  may  be  used  to  counteract 
the  effects  of  fluctuations  in  the  value  of  gold. 

To  follow  the  effects  of  the  supply  of  money  on  price 
we  shall  first  consider  the  question  of  actual  coin  circu- 


SOME   MONEY   PROBLEMS  183 

lation.  Let  us  suppose  that  there  is  a  community 
of  ten  men,  each  doing  business  with  all  the  others. 
And  let  us  further  suppose  that  each  carries  out  the 
same  number  of  transactions,  and  that  the  supply  of 
coins  is  one  gold  piece.  It  is  quite  possible  that  this 
one  gold  piece  is  sufficient  to  pay  for  all  the  transactions, 
if  it  moves  quickly  enough.  A  pays  to  B,  who  passes 
the  coin  to  C,  who  again  hands  the  coin  over,  until 
finally  it  reaches  A  once  more.  This  means,  however, 
that  A  must  wait  until  the  tenth  man,  J,  has  received 
the  coin  before  he  can  be  paid  himself.  Quite  possibly 
one  of  the  men  may  be  anxious  to  gain  the  coin  quickly 
in  order  to  make  an  additional  purchase.  If  D,  for 
instance,  wants  to  receive  the  money  before  C  gets  it, 
he  may  probably  be  able  to  do  so,  by  offering  more 
for  the  coin  to  B  than  C  is  willing  to  offer.  C,  there- 
fore, must  raise  his  offer  to  B  in  order  to  anticipate  D. 
Hence  prices  will  tend  to  fall  very  considerably.  Now 
suppose  we  increase  the  amount  of  coinage  by  adding 
one  other  coin.  If  the  same  number  of  transactions 
is  carried  out  the  coins  will  not  have  to  pass  from  hand 
to  hand  with  the  same  rapidity  as  formerly.  If,  when 
there  was  only  one  coin,  the  whole  of  the  transactions 
were  completed  in  half  a  day,  the  individual  coin 
changed  hands  ten  times  in  that  period.  Now,  when 
there  are  two  coins,  the  individual  coin  only  changes 
hands  five  times  in  half  a  day. 

If  we  suppose  that  the  number  of  transactions 
doubles,  we  may  consider  two  alternatives.  Either 
the  same  number  of  coins  is  used  and  the  rate  of  change 
from  hand  to  hand,  or  the  rapidity  of  circulation,  is 
doubled,  or  else  the  number  of  coins  is  doubled  and  the 


184          AN   INTRODUCTION   TO   ECONOMICS 

old  rate  of  circulation  maintained.  In  either  of  these 
cases  there  will  be  obviously  no  change  in  price  due 
to  the  amount  of  money. 

If  the  number  of  coins  and  the  rate  of  circulation 
remain  unchanged,  then  as  the  number  of  transactions 
increases  there  will  be  an  increasing  intensity  of  de- 
mand for  the  coins  and  hence  a  fall  in  prices.  If,  on 
the  other  hand,  the  number  of  coins  increases  without 
a  corresponding  increase  in  the  number  of  transactions, 
there  will  either  be  a  decrease  in  the  rapidity  of  circula- 
tion or  an  increase  in  prices. 

The  whole  of  this  argument  may  be  expressed  in  the 
form  of  an  equation.  Let  P  equal  price,  generally  ; 
that  is,  not  the  price  of  any  particular  article,  but  an 
average  of  general  prices.  Let  M  represent  the  amount 
of  money  in  circulation  and  V  the  velocity  with  which 
\\  circulates.  Finally,  let  T  equal  the  number  of  trans- 
actions in  the  same  period  for  which  we  have  esti- 
mated the  amount  of  money  in  circulation.  The 
equation  may  then  be  stated  as  follows  : 

MXV 


This  equation,  however,  will  not  quite  accurately 
represent  the  facts  without  a  little  alteration.  Money 
functions  are  performed  by  instruments  which  are  not, 
strictly  speaking,  to  be  regarded  as  money.  Bank 
notes,  government  notes,  token  money,  checks,  and  so 
forth,  all  perform  currency  functions,  and  hence  they 
must  be  taken  into  account.  That  is,  in  our  concep- 
tion of  money  for  the  purposes  of  this  discussion,  we 
must  consider  also  the  presence  of  currency  other  than 


SOME   MONEY   PROBLEMS  185 

standard  money  and  its  velocity  of  circulation.     We 
may,  therefore,  amend  the  equation  to  read  like  this : 

MV+M'V 


P= 


T 


where  Mr  equals  currency  other  than  standard  money, 
and  V  its  velocity  of  circulation. 

From  this  equation  it  will  readily  be  seen  that  any 
increase  in  the  denominator  of  the  fraction,  without  a 
corresponding  increase  in  the  numerator,  will  mean  a 
fall  in  price,  and  any  increase  in  the  numerator,  without 
a  corresponding  increase  in  the  denominator,  will  cause 
a  rise  in  price. 

Fluctuations  in  the  Demand  for  Currency  —  We  have 
already  seen  that  it  is  of  great  importance  in  commerce 
for  price  to  be  as  little  affected  by  fluctuations  in  the 
supply  and  velocity  of  circulation  of  currency  as  possible. 
But  there  always  is  a  fluctuation  in  the  number  of 
commercial  transactions.  There  are  definite  seasonal 
fluctuations  which  occur  with  almost  absolute  regu- 
larity. These  fluctuations  are  due  in  a  large  degree 
to  the  fact  that  crops  are  harvested  usually  only  once 
a  year  and  are  sold  as  soon  as  possible  after  the  harvest. 
There  are  other  causes  with  which  we  need  not  deal. 
We  are  concerned  merely  with  the  fact  that  the  fluctua- 
tions in  the  number  of  transactions  exist. 

In  order,  therefore,  to  make  prices  as  stable  as 
possible,  there  ought  to  be  provision  for  a  corresponding 
fluctuation  in  one  or  more  of  the  factors  in  the  numer- 
ator of  our  fraction.  If  we  consider  these  factors  for 
a  moment,  we  shall  see  that  such  fluctuation,  in  prac- 
tice, must  be  limited  to  the  pair  of  factors  introduced 


186  AN  INTRODUCTION   TO   ECONOMICS 

in  our  second  equation.  The  amount  of  standard 
money  is  dependent  almost  entirely  upon  the  supply 
of  gold.  Sudden  increases  and  decreases  in  this  supply 
are.  not  to  be  looked  for.  The  amount  of  standard 
money  in  circulation  should  be  regarded  as  more  or 
less  constant,  or  stationary.  Moreover,  there  are 
limitations  to  the  possibilities  of  increase  and  decrease 
in  velocity  of  circulation. 

Elastic  Currency  —  Hence  such  fluctuations  as  ac- 
tually take  place  must  occur  in  the  supply  of  sub- 
sidiary currency,  i.e.,  in  the  supply  of  bank  notes, 
government  paper  money,  checks,  and  so  on.  This 
argument  will  help  to  emphasize  the  importance  of  a 
properly  elastic  currency  and  the  care  which  is  neces- 
sary in  evolving  a  satisfactory  system  of  bank-note 
issues. 

If  we  are  able  so  to  arrange  the  amount  of  currency 
and  its  velocity  of  circulation  that  it  increases  just  in 
proportion  as  the  number  of  commercial  transactions 
increases,  and  decreases  as  the  transactions  decrease, 
we  shall  have  achieved  an  almost  perfect  currency  sys- 
tem. Unfortunately,  in  practice  it  is  extremely  diffi- 
cult to  do  so.  Increase  is  easy,  but  decrease  in  the 
amount  of  currency  is  harder  to  obtain.  The  govern- 
ment, for  instance,  can  always  issue  a  supply  of  paper 
currency  based  upon  the  credit  of  the  country.  Such 
currency  is  known  as  fiat  money.  The  difficulty  is 
in  the  retirement  of  that  currency  when  it  is  no  longer 
needed.  The  ease  with  which  the  issue  can  be  made 
has  resulted  in  constant  attempts  in  one  country  after 
another  to  manufacture  paper  money  for  the  needs 
of  government.  It  was  done  in  this  country  at  the 


SOME   MONEY  PROBLEMS  187 

time  of  the  Civil  War.  But  perhaps  the  best  illustra- 
tion of  the  effects  can  be  given  from  the  experience  of 
France  at  the  time  of  the  Revolution. 

Effects  of  Issue  of  Fiat  Money  —  At  that  period  the 
revolutionary  government  confiscated  the  lands  of  the 
nobility  and  clergy.  On  the  security  of  these  lands, 
the  government  issued  paper  money,  known  as  as- 
signats.  The  commerce  of  the  country  did  not  demand 
any  increase  in  the  currency,  and  hence  the  immediate 
effect  was  a  rise  in  prices.  With  the  rise  in  prices,  the 
money  issued  by  the  government  bought  less  goods.  But 
the  apparent  value  of  the  lands,  expressed  in  terms  of  the 
new  money,  was  increased.  Hence  the  government  felt 
justified  in  issuing  more  paper,  with  similar  results. 
Finally  the  money  depreciated  in  value  so  greatly  that 
it  was  hardly  worth  the  paper  on  which  it  was  printed. 

A  similar  effect  would  be  seen  at  present  in  this 
country,  if  the  practice  of  using  Liberty  Loan  Bonds 
as  currency  were  to  spread  to  any  great  extent.  The 
Liberty  Loan  is  based  on  the  credit  of  the  United  States. 
It  is  not  based  upon  the  number  of  commercial  trans- 
actions, and  .the  currency  needs  of  the  country  are 
supplied  from  totally  different  sources.  So,  just  to 
the  extent  that  these  loans  are  used  as  money,  they 
will  adversely  affect  prices.  Of  course,  in  this  case  the 
government  is  not  responsible  for  such  use  of  the  bonds. 
The  government  of  this  country  has  already  had  its 
experience  of  a  paper  currency  unrelated  to  the  cur- 
rency needs  of  the  country,  and  has  no  desire  to  repeat 
that  experience. 

Currency  Inflation  —  When  the  currency  of  a  country 
is  arbitrarily  increased  by  the  issue  of  money  which  is 


188  AN  INTRODUCTION   TO   ECONOMICS 

not  related  to  the  commercial  requirements,  there  is 
said  to  be  money  inflation,  or  inflation  of  the  currency. 
It  is  almost  axiomatic  that  money  inflation  is  to  be 
avoided.  The  reasons  will  be  obvious  to  the  student 
from  the  preceding  argument. 

Measurement  of  Prices.  Index  Numbers  —  One 
question  naturally  arises  from  the  foregoing  discussion. 
How  are  we  to  measure  prices  so  that  we  can  see  the 
influence  of  money  upon  price?  There  are  so  many 
influences  upon  prices,  some  affecting  one  commodity, 
and  some  another,  that  it  would  appear  to  be  almost 
impossible  to  extricate  one  particular  influence.  The 
method  adopted  is  the  use  of  what  are  known  as  index 
numbers.  There  are  many  methods  of  constructing 
these  index  numbers,  and  in  the  present  work  we  can 
do  no  more  than  indicate  the  general  principle  upon 
which  they  are  based. 

What  is  desired  is  some  method  of  showing  the 
changes  in  the  purchasing  power  of  money.  The 
method,  stated  very  simply,  is  as  follows  : 

A  certain  period  is  taken  as  a  standard  The  vary- 
ing amounts  of  a  series  of  different,  but  important,  com- 
modities purchasable  for  one  dollar  are  listed.  Each 
of  these  amounts  is  then  numbered  100.  The  amounts 
purchasable  for  one  dollar  in  the  period  to  be  compared 
with  the  standard  period  are  then  listed  and  again 
numbered  according  to  their  percentage  of  the  amount 
purchasable  in  the  standard  period.  The  average  of 
the  percentage  thus  obtained  will  constitute  the  index 
number  for  the  new  period.  That  is,  it  will  represent 
the  comparative  purchasing  power  of  one  dollar  in 
this  period. 


SOME   MONEY   PROBLEMS  189 

The  idea  is  well  illustrated  by  a  table  compiled  by 
Professor  Seager.1 

JANUARY  1,  FIRST  YEAR  JANUARY  1,  SECOND  YEAR 

$1  —  1  bushel  wheat       -  100  $1  —  f  bushel  wheat   -  -    75 

$1  —  |  ton  coal  —  100  $1  —  £  ton  coal  —  125 

$1  —  2^  ton  iron  —  100  $1  —  ^  ton  iron  —  200 

$1  —  20  yards  cloth        -  100  $1  —  25  yards  cloth      -  125 

$!_  —  10  pounds  copper  —  100  $1  —  5  pounds  copper  —    50 

$5  500  $5  575 

Average     $1  -100  Average     $1  -115 

From  this  it  appears  that  on  the  average  the  pur- 
chasing price  of  one  dollar  has  increased  fifteen  per 
cent.  By  taking  a  large  number  of  commodities  this 
average  increase  in  purchasing  power  is  made  more 
accurate.  In  the  compilation  of  these  index  numbers, 
it  must  always  be  remembered  that  all  commodities  are 
not  of  the  same  importance.  It  would  not  do  to  take, 
for  example,  diamonds,  orchids,  and  violins  as  sample 
commodities. 

The  difficulty  is  met  by  taking  commodities  which 
have  a  very  wide  sale  and  then  "  weighting  "  them  ac- 
cording to  their  importance.  That  is,  an  important 
article,  like  wheat,  for  instance,  may  be  enumerated 
three  times,  while  a  comparatively  unimportant  one 
would  only  appear  once. 

1  Principles  of  Economics,  p.  376. 


CHAPTER  XV 

THE   EVOLUTION   OF   THE   BANKING   SYSTEM 

One  of  the  most  important  elements  of  human 
character  upon  the  existence  of  which  the  modern 
economic  structure  rests  is  general  honesty.  If  we 
did  not  implicitly  believe  that  in  the  main  every  in- 
dividual is  fundamentally  honest,  there  would  be  no 
possibility  for  the  vast  commercial  transactions  which 
continually  take  place  to-day. 

Honesty  the  Basis  of  Economic  Structure  —  Credit 
is  the  basis  of  business,  and  at  bottom,  credit  is  nothing 
more  than  a  belief  that  an  individual  will  carry  out 
his  part  of  a  contract.  In  the  strict  interpretation  of 
the  word  credit,  as  applied  to  business  operations,  we 
may  state  that  a  credit  transaction  involves  a  promise 
to  pay  money  at  some  future  date.  That  is,  there  is 
a  contract  one  part  of  which  is  to  be  fulfilled  at  a  future 
date.  Now,  unless  contracts  such  as  these  were 
habitually  fulfilled  at  the  appointed  time,  there  would 
be  no  possibility  of  conducting  business.  Neverthe- 
less, although  it  is  true  that  there  is  a  general  belief 
in  human  honesty,  that  is  no  reason  why  precautions 
should  not  be  taken  to  prevent  evil  resulting  through 
occasional  failures  to  live  up  to  the  general  reputation. 
Credit  must  be  organized.  In  the  organization  of  credit 
the  banks  play  the  most  important  part.  In  fact  the 
main  function  of  the  banking  business  is  to  organize  credit. 
190 


THE   EVOLUTION   OF   THE   BANKING  SYSTEM       191 

We  can  conceive  of  the  business  of  transportation 
being  carried  on  as  it  is  in  some  parts  of  Spain,  for 
instance,  by  the  use  of  springless  carts  with  solid 
wooden  wheels,  creaking  and  jolting  along  the  bad 
road.  But  we  know  that  if  we,  in  this  country,  had 
to  depend  upon  such  vehicles  the  greater  part  of  our 
commerce  must  cease.  Our  wheels  must  be  lubricated  ; 
our  vehicles  must  be  more  efficiently  designed ;  the 
physical  force  of  the  human  body  must  give  place  to 
the  forces  of  nature  organized  'and  subdued  to  human 
will.  There  is  a  vast  difference  between  the  creaking 
wooden  wheels  of  the  primitive  oxcart  and  the  ball- 
bearings of  the  modern  automobile. 

Banks  the  Lubricants  of  Commerce  —  Just  as  we 
have  progressed  infinitely  from  the  primitive  means 
of  transport  to  the  modern,  so  have  we  also  progressed 
from  primitive  conditions  of  barter-exchange  to  the 
modern  system  of  a  complicated  money  and  credit 
organization.  The  banks  may  be  regarded  as  the 
lubricants  of  trade.  Trade,  indeed,  could  exist  with- 
out banks.  But  it  would  creak  and  jolt  like  the  un- 
greased  wheels  of  an  oxcart.  The  banks  smooth  the 
progress  of  trade;  they  make  possible  transactions 
of  vast  amounts  between  people  widely  separated. 
The  average  individual  seldom  realizes  to  what  extent 
the  comforts  and  graces  of  his  own  life  are  dependent 
upon  the  existence  of  a  good  banking  system. 

Essentially,  the  principles  of  banking  are  not  new. 
Credit  instruments,  inscribed  upon  burnt  bricks,  have 
been  discovered  in  the  ruins  of  ancient  Assyria.  But 
our  modern  banks,  no  matter  what  similarities  they 
may  show  to  ancient  prototypes,  have  not  been  de- 


192  AN   INTRODUCTION   TO   ECONOMICS 

veloped  from  them.  There  is  a  more  definite  develop- 
ment to  be  observed  from  the  period  of  the  discovery 
of  the  New  World.  Without  going  into  history  too 
deeply,  we  may  summarize  the  development  of  the 
banking  institutions  while  gaining  some  idea  of  the 
functions  which  the  banks  exercise. 

Beginning  of  the  Deposit  System  —  Consider,  for  a 
moment,  the  position  of  a  medieval  merchant  who 
desired  a  safe  place  to  keep  his  money,  which  was  en- 
tirely composed  of  coin  or  bullion.  He  seldom  had  a 
proper  place  to  keep  the  money,  and  yet  thieves  were 
even  more  common  then  than  now,  in  spite  of  the  greater 
severity  of  the  laws.  One  kind  of  merchant  was  com- 
pelled by  the  nature  of  his  business  to  have  a  strong 
place  in  which  to  keep  his  merchandise.  That  was 
the  goldsmith.  The  materials  of  his  business  were  at 
the  same  time  the  materials  of  which  money  was  made. 
What  could  be  more  natural,  therefore,  than  the  sug- 
gestion that  the  goldsmith  be  asked  to  care  for  the 
surplus  money  of  the  other  merchants  ?  For  a  small 
percentage  of  the  sum  cared  for,  the  goldsmith  was 
willing  to  keep  the  money  in  his  own  vaults,  safe,  as 
far  as  anything  could  be  safe  in  those  days,  from  the 
attacks  of  thieves.  The  merchant  could  draw  out 
his  money  as  he  pleased,  and  it  was  worth  while  for 
him  to  pay  a  little  to  the  goldsmith  for  guarding  the 
money. 

But  the  goldsmith,  being  the  merchant  who  had  the 
greatest  store  of  money  material,  was  also  the  individual 
to  whom  borrowers  naturally  applied  for  loans.  From 
these  two  facts  we  can  develop  the  beginning  of  a 
banking  system.  The  merchants  who  left  their  money 


THE   EVOLUTION   OF   THE   BANKING  SYSTEM       193 

with  the  goldsmith  for  safekeeping  were  the  original 
depositors.  Those  who  borrowed  from  the  goldsmith 
correspond  to  our  present-day  bank  clients. 

It  would  occur,  sooner  or  later,  to  the  goldsmith, 
that  he  was  seldom  called  upon  to  return,  at  any  one 
time,  the  whole  of  the  sums  deposited  with  him.  There 
would  appear  to  be  no  reason  why  he  should  not  use 
some  of  these  deposited  funds  to  lend  to  his  clients, 
thus  reaping  interest  from  both  depositors  and  bor- 
rowers. But  this  could  not  be  kept  secret  indefinitely. 
Competition  among  the  goldsmiths  for  deposits  which 
they  could  lend  out  would  soon  convince  the  depositors 
that  then*  money  was  not  always  intact  in  the  gold- 
smith's vaults.  Competition  would  also  lead  to  the 
solicitation  of  deposits  backed  by  offers  to  receive  such 
deposits  and  care  for  them  without  charge,  and  even, 
later  on,  to  pay  a  small  rate  of  interest  to  the  depositor. 
We  have  here  two  of  the  chief  functions  of  a  bank  — 
the  deposit  of  money  and  the  lending  of  money.  It  is 
but  a  little  step  to  the  third  of  these  functions,  the 
issue  of  bank  notes. 

Bank  Notes.  Origin  —  Money  was  subject  to  con- 
siderable difficulty  in  transport.  It  was  liable  to  theft 
very  easily.  An  order  on  a  banker,  however,  or  on  a 
goldsmith  could  be  carried  easily,  and  if  stolen,  need 
involve  no  loss,  for  the  order  could  be  made  payable 
only  to  a  certain  definite  individual.  Such  orders, 
checks  we  call  them  now,  soon  became  fairly  common. 
Indeed,  they  were  not  unknown  in  ancient  Rome.  A 
merchant  who  wished  to  make  a  payment  to  another 
at  a  distance  could  obtain  from  a  goldsmith  an  order 
upon  another  goldsmith  residing  at  the  place  where 


194  AN  INTRODUCTION   TO   ECONOMICS 

payment  was  to  be  made.  He  could  then  forward  that 
order  to  his  creditor,  who  obtained  the  money  from  the 
goldsmith  upon  whom  the  order  was  drawn.  Similarly 
this  second  goldsmith  could  issue  orders  upon  the  first. 
The  cross  transactions  would  tend  to  cancel  one  an- 
other and  any  balances  could  be  carried  out  by  the 
actual  transfer  of  gold.  This  would  only  have  to  be 
done  occasionally,  however,  and  the  goldsmiths  would 
be  in  the  habit  of  taking  extraordinary  precautions  in 
such  shipments. 

An  order  upon  a  goldsmith  of  recognized  standing 
would  soon  tend  to  be  regarded  as  equivalent  to  cash 
and  consequently  would  be  passed  from  hand  to  hand 
as  such.  The  orders,  therefore,  might  be  outstanding 
for  a  considerable  time  before  they  were  presented 
for  final  payment.  The  goldsmith,  in  the  meantime, 
would  be  able  to  lend  out  the  funds  against  which  the 
orders  were  drawn  and  so  obtain  additional  profit  from 
the  interest  gained  from  the  loan.  Hence  he  would 
be  anxious  to  have  as  many  of  these  orders  outstand- 
ing as  possible.  The  natural  result  was  that  he  issued 
his  own  orders  drawn  upon  his  own  funds.  These  were 
rather  promises  to  pay  than  orders.  They  consisted 
of  a  promise  to  pay  the  bearer  on  demand  the  sum 
named  in  the  note.  This  is  all  that  a  bank  note  is  at 
present. 

The  Deposit  System  —  Essentially  we  have  now  all 
the  elements  of  a  bank.  But  a  bank  is  somewhat  more 
complicated  than  this  and  we  shall  now  attempt  an 
analysis  of  the  functions  indicated  above.  First,  let 
us  consider  the  deposit  system.  Let  us  imagine  that 
there  exists  a  community  of  ten  merchants,  who  keep 


THE   EVOLUTION   OF   THE   BANKING   SYSTEM       195 

their  funds  deposited  in  one  bank.  Let  us  suppose 
further  that  each  one  has  on  deposit  the  sum  of  $1000. 
These  merchants  trade  with  each  other  and  conse- 
quently at  times  one  has  to  pay  the  other  for  goods 
or  to  receive  money  for  sales  made.  A,  let  us  say, 
buys  $100  worth  of  goods  from  B.  He  makes  pay- 
ment to  B  by  giving  him  an  order  on  the  bank,  some- 
what as  follows : 

To  the  Bank  of  X,  Blankville.  October  10,  1918 

Pay  to  the  order  of  B  the  sum  of  one  hundred  dollars.     ($100) 

(signed)     A. 

B  presents  that  order  to  the  bank  and  may  do  one 
of  two  things.  He  may  request  the  payment  of  the 
$100  in  cash,  or  he  may  ask  that  the  amount  be  added 
to  his  own  account.  Probably  he  does  the  latter.  If 
so,  all  that  occurs  is  a  bookkeeping  transaction  in  the 
bank.  A's  account  is  reduced  to  $900  and  B's  is  in- 
creased to  $1100.  No  cash  has  been  required.  B, 
however,  is  also  trading  with  C  and  with  D  and  so  he 
must  make  his  payments.  He  does  so  by  drawing  his 
check  in  the  same  manner  as  A.  Seeing  that  all  the 
accounts  are  contained  in  one  institution,  there  should 
be  no  need  of  cash  at  all,  for  all  that  is  necessary  is 
the  transfer  of  amounts  from  one  account  to  the  other. 

Necessity  for  Bank  Deposit  Reserves  —  This  is 
simple  enough  when  there  is  only  one  institution.  But 
that  is  seldom  the  case.  Before  we  consider  the  situa- 
tion when  there  are  two  or  more  banks,  let  us  discuss 
the  position  of  the  bank  itself.  It  is  quite  possible 
that  each  of  its  depositors  has  some  relations  outside 
the  other  nine  merchants,  for  which  a  certain  amount 


196  AN   INTRODUCTION   TO   ECONOMICS 

of  cash  will  be  required.  The  merchants  themselves, 
for  instance,  will  require  some  funds  for  small  pur- 
chases, like  traveling  expenses,  for  which  checks  are 
seldom  used.  They  will,  therefore,  call  upon  the  bank 
to  pay  back  a  certain  amount  of  their  deposits  when  they 
require  such  funds.  The  bank  must  be  prepared  to 
meet  these  demands,  and  therefore  it  will  be  compelled 
to  have  a  certain  amount  of  actual  money  ready  to 
hand  over  the  counter.  Again  it  is  possible  that  one 
of  the  merchants  may  give  up  business  and  leave  the 
town,  in  which  case  he  will  withdraw  all  his  funds. 
The  bank  must  be  ready  to  pay  back  at  any  time.  But 
it  may  safely  reckon  on  the  fact  that  the  amount  of 
withdrawals  in  any  one  day  will  represent  only  a  small 
fraction  of  the  total  amount  deposited.  If,  therefore, 
the  bank  maintains  sufficient  funds  on  hand  to  meet 
what  demands  arise,  it  may  use  the  remainder  for  the 
purpose  of  making  loans.  The  amount  of  reserve, 
as  these  cash  funds  are  called,  will  vary  according  to 
conditions  of  trade,  but  there  will  always  be  a  surplus 
available  for  loans.  The  bank,  then,  protects  its  de- 
positors' immediate  needs  by  a  reserve  of  cash  and 
makes  its  profits  by  extending  loans  to  its  customers. 
The  more  nearly  its  depositors  comprise  all  the  mer- 
chants of  the  community,  the  smaller  will  the  reserve 
fund  need  to  be. 

The  Case  of  Two  or  More  Banks.  —  Now  we  may 
return  to  the  case  of  two  or  more  institutions.  Sup- 
pose there  are  two  banks,  each  with  five  depositors, 
A,  B,  C,  D,  E,  and  F,  G,  H,  I,  and  J  respectively. 
Now  if  A  pays  a  check  to  B,  B  will  deposit  it  in 
A's*  own  bank,  and  so  the  transaction  will  be  similar 


THE   EVOLUTION   OF   THE   BANKING   SYSTEM       197 

to  that  already  described,  i.e.,  a  bookkeeping  opera- 
tion within  the  bank.  But  suppose  A,  instead  of 
drawing  his  check  in  favor  of  B,  makes  it  out  to  F. 
In  this  case  F  will  deposit  the  check  in  his  own  bank. 
That  bank  must  then  collect  the  money  from  the  other. 
It  is  possible  that  to  do  so  a  messenger  will  be  sent 
from  the  second  bank  to  the  first,  carrying  the  check 
with  him  and  receiving  cash  from  the  teller  at  the  first 
bank. 

But  A's  check  is  not  the  only  one  that  will  be  drawn 
in  the  course  of  the  day.  H  may  draw  a  check  in  favor 
of  C,  who  will  deposit  it  in  bank  number  one.  This 
bank  will,  possibly,  also  send  a  messenger,  carrying  the 
check  for  payment  to  the  second  bank.  It  is  con- 
ceivable, therefore,  that  the  two  messengers  may  pass 
each  other  in  the  street  carrying  money  from  the  two 
banks. 

This  is  obviously  a  waste  of  currency.  It  would 
be  better  for  each  of  the  banks  to  wait  until  the  end 
of  the  day  and  then  find  out  how  much  money  each 
owes  the  other,  settling  the  balance  in  cash.  This 
would  be  perfectly  simple  in  the  case  of  two  institutions, 
but  in  any  large  city  there  are  many  more  banks  than 
two,  and  the  difficulty  of  balancing  up  each  day  is, 
consequently,  much  greater.  Still  the  essential  prin- 
ciple is  the  same,  though  the  mechanism  is  a  little 
more  complicated. 

The  Clearing  House  —  Let  us  suppose  that,  in  a 
certain  city,  there  are  ten  banks.  These  banks  will 
form  a  "  clearing  house  association  "  for  the  purpose 
of  balancing  their  indebtedness  each  day.  Each  bank 
will  be  numbered.  At  the  close  of  the  day  the  checks 


198  AN   INTRODUCTION   TO   ECONOMICS 

received  in  each  of  the  banks  will  be  arranged  into 
groups.  The  first  group  will  consist  of  checks  drawn 
upon  the  bank  in  which  they  were  deposited.  These 
will  be  cared  for  by  bookkeeping  transfers  in  the  bank 
itself.  The  remaining  nine  will  each  consist  of  checks 
drawn  upon  one  bank.  The  first  will  have  all  checks 
drawn  upon  bank  number  two,  the  next  all  checks  drawn 
on  bank  number  three,  and  so  on.  These  checks  will 
be  wrapped  up  in  separate  bundles  after  the  total 
amount  represented  on  their  face  has  been  checked. 

At  a  certain  definite  time  next  morning  two  messen- 
gers will  be  sent  to  the  clearing  house,  carrying  with 
them  the  bundles  of  checks.  They  carry  also  a  state- 
ment showing  the  amount  drawn  upon  each  of  the 
other  banks  and  the  total  amount  due  from  all.  The 
clearing  house  will  be  illustrated  better  by  reference  to 
the  diagram  (Fig.  6).  At  a  central  table  sits  the  clerk 
of  the  clearing  house.  Around  this  table  are  grouped 
in  a  circle  ten  desks,  each  assigned  to  a  particular 
bank.  On  arrival  at  the  clearing  house,  one  of  the 
messengers  hands  to  the  clerk  of  the  clearing  house  a 
copy  of  the  statement  of  the  amounts  due  to  his  bank. 
The  other  messenger  takes  his  place  at  the  desk  al- 
lotted to  his  bank.  The  first  messenger  carries  the 
nine  bundles  of  checks,  each  bearing  a  slip  stating  the 
amount  due  upon  the  checks  in  the  bundle.  He  also 
takes  his  position  at  the  desk  belonging  to  his  bank. 
Before  the  signal  to  commence  operations,  each  desk 
will  be  attended,  therefore,  by  two  messengers.  At  a 
given  signal,  usually  the  striking  of  a  bell,  the  messenger 
from  bank  number  one  will  start  for  the  desk  of  bank 
number  two.  There  he  will  deposit  the  bundle  of 


THE   EVOLUTION   OF   THE   BANKING   SYSTEM       199 


checks  drawn  upon  that  bank,  receiving  a  receipt  for 
the  amount  stated  on  the  slip.     He  will  then  pass  on 


FlG-6-Oia^rom  to  Illustrate    Clearing  House 


C.  H.C,  -    CLEARING    HOUSE     CLERK. 
R  -     RECEIVING     MESSENGER, 

0  -      DELIVERING    MESSENGER. 


to  the  desk  of  bank  number  three  and  repeat  the  per- 
formance.    Meanwhile  the  messenger  from  the  tenth 


200  AN   INTRODUCTION   TO    ECONOMICS 

bank  will  have  handed  a  bundle  to  the  messenger  at 
the  desk  of  the  first,  then  proceeding  to  the  second 
desk.  So  the  messengers  will  circulate  until  each  has 
passed  in  his  nine  bundles  and  returned  to  his  own  bank, 
bearing  nine  initialed  slips  which  constitute  receipts 
for  the  bundles  of  checks  handed  over. 

Debtor  and  Creditor  Banks  —  The  receiving  mes- 
sengers have  occupied  themselves  in  totaling  the 
amounts  stated  on  the  bundles  handed  to  them.  They 
know,  of  course,  how  much  is  due  to  their  own  banks, 
from  the  statement  brought  with  them.  When  they 
have  completed  the  new  total  they  are  able  to  draw 
a  balance  between  the  two.  If  they  find  that  the 
amount  due  from  the  other  banks,  as  represented  in 
their  first  statement,  is  greater  than  the  amount  due 
from  their  own  bank,  as  shown  in  the  total  which  they 
have  just  calculated,  the  balance  is  in  favor  of  their 
own  bank,  which  is  known,  for  the  day,  as  a  creditor 
bank.  If,  on  the  other  hand,  the  statement  which  was 
made  up  by  their  own  bookkeepers  is  less  than  the 
total  of  the  bundles  of  checks  drawn  upon  their  bank, 
then  their  bank  is  a  debtor. 

Obviously  all  banks  cannot  be  debtor,  or  all  creditor. 
The  amount  of  the  debits  must  equal  that  of  the  credits. 
If  the  amounts  do  not  agree,  some  one  has  made  a 
mistake,  whereupon  each  clerk  makes  a  recast  of  his 
totals  to  find  the  error.  Meanwhile,  the  clerk  of 
the  clearing  house  has  also  made  his  comparison 
from  the  statements  handed  to  him  before  the  open- 
ing of  the  clearing.  From  these  statements  he  pre- 
pares a  summary  of  all  the  transactions,  and  has,  at 
the  end,  a  statement  which  should  agree  with  the 


THE   EVOLUTION   OF   THE   BANKING   SYSTEM       201 

combined  calculations  of  the  messengers  from  the 
member  banks. 

The  balances  are  paid  either  in  cash,  or,  sometimes, 
by  checks.  Thus  the  use  of  money  is  economized  to 
an  enormous  extent.  Without  the  clearing  house,  the 
use  of  checks  in  payment  of  commercial  transactions 
would  be  very  greatly  curtailed. 

The  Bank  Loan  —  So  far,  we  have  dealt  only  with 
the  deposit  system,  but  we  have  not  considered  an 
extremely  important,  indeed,  an  essential  function 
of  the  bank  —  the  lending  of  money.  A  bank's  profits 
depend  upon  the  quantity  of  successful  loans  made. 
They  consist  almost  entirely  of  the  interest  charged 
for  these  loans.  A  loan  may  be  made  in  three  forms. 
The  borrower  may  receive  government  currency  over 
the  counter,  or  he  may  receive  bank  notes  of  the  lend- 
ing bank.  The  greatest  amount  of  loans,  however,  is 
made  in  the  form  of  a  deposit.  Let  us  see  why  this 
is.  Suppose  a  borrower  obtains  a  loan  from  the  bank 
amounting  to  $10,000.  It  is  conceivable  that  the  bank 
may  pay  him  in  gold.  But  the  borrower  seldom  re- 
quires the  whole  amount  of  the  loan  immediately. 
He  wants  to  be  able  to  have  sums  from  time  to  time  as 
required.  He  will  naturally,  therefore,  want  a  safe 
place  to  keep  the  money  until  the  time  comes  to  spend 
it.  What  safer  place  can  he  have  than  the  bank? 
Consequently,  having  received  the  coin,  he  deposits 
it  to  his  credit,  and  draws  checks  against  the  deposit. 

The  gold,  therefore,  will  be  paid*  out  by  the  paying 
teller  and  carried  to  the  receiving  teller's  window  and 
there  deposited.  This  means  that  the  gold  will  have 
passed  out  at  one  window  and  in  at  another.  There 


202  AN  INTRODUCTION   TO   ECONOMICS 

is  no  reason  why  the  transaction  could  not  be  done  by 
entering  the  amount  of  the  loan  directly  into  the  pass- 
book of  the  depositor,  who  is  also  the  borrower.  This, 
in  fact,  is  what  actually  happens.  When  the  borrower 
negotiates  the  loan  with  the  bank,  instead  of  receiving 
currency  in  any  form,  he  has  the  amount  of  the  loan 
credited  to  him  and  he  then  uses  the  account  to  draw 
checks  with  which  to  make  his  payments. 

Accommodation  Loans  —  We  may  divide  the  pur- 
poses for  which  loans  are  made  by  banks  into  three 
classes.  First,  there  are  those  "loans  which  are  purely 
for  the  purpose  of  accommodating  the  borrower.  The 
reason  why  the  borrower  wants  the  money  is  not  ap- 
parent. He  may  wish  to  take  a  trip  to  Europe,  or  to 
buy  an  automobile,  or  to  redecorate  his  house,  or  any 
of  a  multitude  of  different  methods  of  spending.  Loans 
of  this  type  are  known  as  accommodation  loans,  and 
the  notes  signed  as  evidence  of  the  obligation  are 
called  accommodation  paper.  This  type  of  loan  was 
extremely  common  in  earlier  history.  A  good  example 
is  that  contained  in  The  Merchant  of  Venice.  Bassanio, 
in  borrowing  money  from  Antonio,  merely  desired  to 
make  a  brave  show  when  he  went  to  court  Portia. 

Capital  Loans  —  The  second  type  is  that  secured  by 
borrowers  who  wish  to  add  to  their  working  capital. 
If  a  firm,  for  instance,  has  spent  all  its  present  capital 
in  the  purchase  of  buildings  and  machinery,  and  re- 
quires additional  funds  to  provide  for  the  working 
expenses  of  the  business  before  the  returns  begin  to 
come  in,  it  frequently  negotiates  a  loan  with  a  bank. 
The  first  type  of  loan  is  usually  made  not  on  the  credit 
of  the  borrower,  but  on  the  value  of  security  deposited 


THE   EVOLUTION   OF  THE   BANKING  SYSTEM       203 

with  the  bank.  A  pawnbroker's  loans  are  of  this 
type.  The  second  may  be  made  either  on  security 
offered,  or  on  the  credit  of  the  borrower.  If  the  bank 
believes  that  the  borrower  has  sufficient  capital  already 
invested  in  his  business  to  make  it  pay,  and  that  he  is 
a  capable  and  honest  business  man,  the  loan  may  be 
made  without  any  security  other  than  this  belief. 

Commercial  Loan  —  The  third  type  of  loan  is  ob- 
tained for  the  purpose  of  facilitating  commercial  opera- 
tions, the  purchase  and  sale  of  goods.  Let  us  suppose 
that  a  merchant  has  sold  a  thousand  dollars'  worth  of 
dry  goods.  He  gives,  let  us  say,  thirty  days'  credit. 
That  means  that  for  thirty  days  he  must  wait  before 
receiving  payment.  Most  likely  he  will  find  that  some 
time  during  that  thirty  days  he  could  make  good  use 
of  the  money.  If  he  cannot  obtain  it,  profits,  other- 
wise possible,  will  be  lost.  He  therefore  goes  to  the 
bank  and  obtains  a  loan  on  the  strength  of  the  money 
due  to  him  at  the  end  of  thirty  days.  Frequently,  and 
much  more  so  of  late  years,  the  debtor  will  sign  some 
form  of  obligation,  agreeing  to  make  the  payment  at 
the  maturity  of  the  credit  period.  This  obligation 
will  be  indorsed  by  the  creditor  and  handed  to  the 
bank.  The  latter  then  becomes  the  legal  owner  of 
the  sum  mentioned  at  the  maturity,  and  the  retail  dry 
goods  merchant  will  pay  the  sum  stated  on  the  note  to 
the  banker  when  it  is  presented. 

Discount  —  The  merchant  to  whom  the  money  was 
originally  due  will  receive  from  the  bank  a  sum  slightly 
less  than  the  amount  called  for  in  the  note,  the  differ- 
ence being  the  banker's  profit  on  the  transaction. 
Such  a  loan  is  usually  referred  to  as  a  discount.  The 


204  AN  INTRODUCTION   TO   ECONOMICS 

bank  "  discounts  "  the  note  indorsed  by  the  merchant 
to  whom  the  money  is  due.  This  particular  type  of 
loan  is  called  a  commercial  loan  from  the  nature  of  the 
transaction  on  which  it  is  based.  Its  importance 
in  the  operations  of  commerce  can  hardly  be  exagger- 
ated. Few  retailers  can  afford  to  carry  a  stock  suf- 
ficient for  the  needs  of  their  customers,  unless  they  are 
allowed  a  certain  time  to  sell  the  goods  before  being 
called  upon  to  pay  the  wholesale  dealer  from  whom  the 
goods  were  bought.  If  there  were  no  possibility  of 
discounting  the  evidences  of  indebtedness  on  the  part 
of  the  retail  dealers,  the  wholesale  merchant  would 
often  be  unable  to  give  reasonable  credit  terms  without 
curtailing  the  amount  of  business  done.  If  there  were 
no  means  of  discounting,  the  loss  would  fall  heavily 
upon  the  consumer,  for  higher  prices  would  undoubtedly 
be  the  result.  The  merchants,  having  to  wait  for  their 
money,  would  be  compelled  to  ask  higher  prices  from 
their  customers,  and  these  higher  prices  would  in- 
evitably be  passed  on  to  the  consuming  public. 

Value  of  Discount  System  —  The  fact  that  the  banks 
stand  ready  to  discount  commercial  paper,  therefore, 
allows  the  retailer  a  reasonable  credit  period,  and  at 
the  same  time  permits  the  wholesale  dealer  and  manu- 
facturer to  turn  over  their  capital  much  of  tener,  thereby 
making  possible  greater  production  and  a  consequent 
increase  in  the  total  satisfaction  gained  by  the  com- 
munity. It  further  provides  for  the  full  utilization 
of  idle  capital,  for  the  increased  production  calls  for 
greater  working  capital,  and  that  greater  capital  is 
drawn  from  otherwise  idle  funds  in  the  hands  of 
bankers. 


THE   EVOLUTION   OF   THE   BANKING   SYSTEM       205 

Bank  Notes  —  The  third  of  the  banking  functions 
is  the  issue  of  bank  notes.  A  batik  note  is  nothing 
more  nor  less  than  a  promise  on  the  part  of  a  bank  to 
pay  a  certain  sum  on  demand  in  lawful  currency. 
There  is  a  technical  similarity  between  an  ordinary 
demand  promissory  note  and  a  bank  note.  But  the 
difference  consists  partly  in  the  fact  that  the  signa- 
ture of  the  bank  officials  on  the  note  is  taken  without 
question,  whereas  the  signature  of  a  private  promissory 
note  usually  must  bear  investigation  before  it  can  be 
generally  accepted,  and  partly  in  the  fact  the  govern- 
ment regulates  the  issue  of  bank  notes  so  as  to  protect 
holders,  whereas  the  holders  of  ordinary  promissory 
notes  have  only  recourse  to  the  provisions  of  the  law 
governing  negotiable  instruments.  The  bank  has  an 
identity  which  differs  from  that  of  a  private  individual, 
in  that  it  is  regarded  almost  without  question  as  a  safe 
institution.  In  order  that  the  reputation  may  be 
deserved,  in  every  civilized  country  the  methods  of 
banking  are  subject  to  regulation  by  government.  In 
our  next  chapter  we  shall  consider  the  method  of  regu- 
lation adopted  by  the  United  States. 


CHAPTER  XVI 

THE   AMERICAN   BANKING   SYSTEM 
I.   THE  NATIONAL  BANKS 

It  is  impossible  in  a  brief  outline  to  give  anything 
like  an  adequate  account  of  the  banking  systems  in 
vogue  in  the  United  States.  Hardly  any  system  tried 
in  any  country  has  been  without  its  example  in  Ameri- 
can procedure.  At  best  all  that  can  be  done  here  is 
to  outline  the  essentials  of  the  present  system  and 
leave  the  detailed  study  to  texts  on  banking.  We 
shall,  therefore,  neglect  the  consideration  of  the  varie- 
ties of  State  institutions,  merely  remarking  that  with 
the  exception  of  the  note-issuing  power  they  are  not 
very  dissimilar  from  the  National  banks,  and  confine 
our  attention  to  the  two  outstanding  institutions,  the 
National  banks  and  the  Federal  Reserve  banks. 

Early  History  —  The  early  history  of  banking  in 
the  United  States  provided  illustrations  of  the  best  and 
the  worst  forms  of  banks.  Generally  speaking,  how- 
ever, up  to  the  time  of  the  Civil  War  the  banking 
conditions  of  the  country,  from  whatever  point  they 
could  be  regarded,  were  unsatisfactory.  The  issuing 
of  bank  notes  was  uncontrolled  and  the  notes  varied 
in  value  according  to  the  standing  of  the  institution 
which  issued  them.  The  reserves  maintained  against 
deposits  were  in  many  cases  totally  inadequate.  The 
206 


THE    AMERICAN    BANKING    SYSTEM  207 

risks  taken  by  the  bankers  in  making  loans  were  too 
highly  flavored  with  speculation  to  be  considered  in 
any  way  sound  banking. 

The  currency  difficulties  of  the  country  at  the  time 
of  the  outbreak  of  war  were  not  entirely  due  to  the 
banking  system,  but  they  were  intimately  connected 
with  it.  Three  problems,  in  this  connection,  faced 
the  government.  First,  the  country  must  be  provided 
with  a  sound  currency  system.  Second,  the  safety  of 
the  funds  belonging  to  depositors  must  be  guaranteed 
in  a  much  more  satisfactory  manner  than  formerly. 
The  third  problem  was  not  necessarily  connected  with 
the  banking  system  but  it  influenced  the  design  of  the 
new  system  very  materially.  Funds  were  necessary 
for  war  purposes  and,  as  these  funds  were  to  be  ob- 
tained by  the  sale  of  government  bonds,  a  market  for 
these  bonds  had  to  be  found.  The  government  tried 
to  solve  all  these  problems  by  forming  the  National 
banking  system. 

National  Banking  Act  —  The  Act  which  formed 
this  system  is  known  as  the  National  Banking  Act, 
and  was  passed  in  1863.  Since  that  time  it  has  been 
frequently  amended,  but  we  shall  not  deal  with  the 
amendments  separately.  In  principle,  the  Act  may 
be  briefly  described  as  follows : 

Minimum  of  Capital  —  The  government  issued  charters 
to  banking  institutions  which  complied  with  the  stipulations 
laid  down  in  the  Act.  These  institutions  were  compelled 
to  possess  a  certain  minimum  of  capital,  which  varied  accord- 
ing to  the  number  of  the  population  served  by  the  bank,  but 
was  not  allowed  to  fall  below  $25,000  in  any  place.  In 
addition  to  the  capital,  each  bank  had  to  lay  by  a  certain 


208  AN    INTRODUCTION   TO   ECONOMICS 

portion  of  its  profits  each  year  to  form  a  "surplus,"  until 
the  surplus  amounted  to  twenty  per  cent  of  the  paid-up 
capital. 

Bond  Purchases  and  Note  Issues  —  The  smaller  banks  were 
to  buy  government  bonds  to  the  extent  of  one  quarter  of 
their  paid-up  capital,  the  larger  banks  buying  a  minimum 
of  $50,000  worth.  By  this  it  was  hoped  that  the  de- 
sired market  for  government  bonds  would  be  provided.  Of 
course,  it  was  not  to  be  expected  that  the  banks  should  be 
deprived  of  the  use  of  so  much  of  their  capital,  and  so  each 
bank  was  allowed  to  issue  bank  notes  to  the  extent  of,  at 
first,  ninety  per  cent,  and  later,  one  hundred  per  cent  of  the 
face  value  of  the  bonds.  The  bonds  were  held  by  the  Treas- 
ury as  security  for  the  bank  notes  issued.  In  this  way  the 
security  of  the  bank  notes  rested  upon  the  credit  of  the 
federal  government.  Thus  two  of  the  problems  were  sup- 
posed to  be  solved. 

Reserves  —  In  regard  to  the  third  problem,  the  safeguard- 
ing of  depositors,  the  Act  laid  down  rules  for  the  main- 
tenance of  minimum  reserves,  and  directed  the  manner  in 
which  these  reserves  were  to  be  kept.  First,  the  banks  of 
the  country  were  divided  into  three  classes.  Those  situated 
in  New  York,  Chicago,  and  St.  Louis  were  called  Central 
Reserve  City  banks.  Forty-nine  other  cities  were  named  as 
Reserve  cities.  All  National  banks  si'tuated  outside  of 
these  fifty  cities  were  termed  Country  banks.  The  reserves 
required  under  the  act  varied  according  to  the  status  of  the 
bank.  Central  Reserve  City  banks  were  required  to  main- 
tain minimum  deposit  reserves  of  twenty-five  per  cent  of 
the  total  deposits,  these  reserves  to  be  in  cash  carried  in 
the  vaults  of  the  individual  banks.  The  Reserve  City 
banks  were  also  required  to  maintain  reserves  of  twenty-five 
per  cent,  but  with  this  difference ;  in  their  case  only  twelve 
and  a  half  per  cent  of  the  deposits  need  be  kept  in  cash 


THE    AMERICAN   BANKING   SYSTEM  209 

carried  in  the  vaults  of  the  bank.  The  other  half  of  the 
reserves  might  be  left  on  demand  deposit  with  a  National 
bank  in  a  Central  Reserve  city. 

In  the  Country  banks,  a  reserve  of  fifteen  per  cent  had  to 
be  kept,  six  per  cent  being  cash  in  vaults,  and  the  remainder 
on  deposit  in  Central  Reserve  or  Reserve  cities. 


Bank  Examinations  —  The  business  community  was 
protected  against  unwise  banking  by  prohibitions  of 
certain  forms  of  loans  which  were  of  too  speculative  a 
nature,  and  by  a  system  of  periodical  examinations 
conducted  by  federal  examiners.  The  Secretary  of 
the  Treasury  might  also  call  for  reports  as  often  as 
five  times  each  year. 

Criticism  of  the  System  —  The  system  thus  out- 
lined was  undoubtedly  a  very  great  improvement  over 
that  which  had  preceded  it,  but  it  did  not  really  solve 
the  problems  which  led  to  its  adoption.  In  the  first 
place,  the  market  for  government  bonds  was  not  very 
widely  increased.  There  was  no  prohibition  on  the 
issue  of  bank  notes  by  other  institutions  than  National 
banks.  It  was  assumed  that  the  State  banks,  that  is, 
the  banks  which  operated  under  charters  given  by  the 
States,  as  distinguished  from  federal  charters,  would 
flock  to  join  the  new  system.  Most  of  them,  however, 
preferred  to  retain  the  more  elastic  procedure  allowed 
under  the  State  laws.  To  remedy  this  defect,  an  act 
was  passed  in  1865  which  imposed  a  tax  of  ten  per  cent 
upon  bank  note  issues  other  than  those  of  National 
banks.  This  was  not,  in  form,  a  direct  prohibition, 
but  in  practice  it  amounted  to  such.  The  number  of 
National  banks  immediately  increased  very  greatly. 


210  AN   INTRODUCTION   TO   ECONOMICS 

The  provision  of  a  market  for  bonds,  however,  was 
a  minor  and  temporary  consideration.  The  two  im- 
portant purposes  of  the  act  were  to  remedy  the  cur- 
rency and  to  safeguard  the  depositors.  Let  us  see 
how  the  provisions  of  the  act  succeeded  in  these  respects. 

National  Bank  Notes  —  A  bank  note  is,  as  we  have 
said  in  a  previous  chapter,  merely  a  promise  on  the 
part  of  a  bank  to  pay  to  bearer,  on  demand,  the  sum 
mentioned  on  the  face  of  the  note.  If  the  bearer  can 
always  rely  upon  the  fulfillment  of  the  promise,  the 
note  issue  is  kept  up  to  a  par  with  the  rest  of  the  money 
of  the  country.  The  note  must,  therefore,  be  ade- 
quately secured.  But  there  are  two  points  of  view  to 
be  considered  in  determining  the  security  of  the  note 
—  the  ultimate  and  the  immediate  security.  In  re- 
gard to  the  ultimate  security,  provision  must  be  made 
for  the  repayment  of  the  face  value  of  the  note  when 
the  note  is  finally  retired.  In  the  case  of  the  National 
bank  note,  that  security  is  found  in  the  deposit  of 
government  bonds  with  the  Treasury  of  the  United 
States.  If  a  bank  should  fail,  the  bonds  will  be  sold 
to  pay  the  holders  of  the  notes  issued  by  the  bankrupt 
institution.  In  case  the  bonds  do  not  realize  their 
own  face  value,  the  balance  due  to  the  note  holders 
constitutes  a  first  charge  upon  the  assets  of  the  bank. 
It  would  appear,  therefore,  that  the  note  holders  are 
adequately  secured  as  far  as  the  ultimate  redemption 
of  the  notes  is  concerned. 

Redemption  of  Notes  —  But  there  is  a  second  point 
of  view  which  is  of  almost  greater  importance.  It  is 
not  sufficient  that  the  ultimate  security  of  the  notes 
be  protected.  Their  immediate  redemption  on  de- 


THE   AMERICAN   BANKING   SYSTEM  211 

mand  is  a  primary  necessity.  To  satisfy  this  require- 
ment, the  Act  provided  that  in  addition  to  the  bonds 
deposited  with  the  Treasury,  each  bank  must  main- 
tain a  fund,  in  gold,  amounting  to  five  per  cent  of  the 
notes  issued,  with  the  Secretary  of  the  Treasury. 
From  this  fund  notes  were  to  be  redeemed.  Further, 
all  National  banks  were  compelled  to  accept  National 
bank  notes,  no  matter  where  issued,  at  face  value  as 
deposits. 

Suppose  the  National  City  Bank  of  New  York  re- 
ceives on  deposit,  $5000  of  notes  issued  by  the  First 
National  Bank  of  San  Francisco.  The  National  City 
Bank  will  forward  these  notes  to  the  Treasury  and 
$5000  will  be  transferred  from  the  redemption  fund 
belonging  to  the  First  National  of  San  Francisco  to 
that  belonging  to  the  National  City  Bank.  The  San 
Francisco  bank  will  then  be  informed  by  the  Treasury 
that  $5000  of  its  notes  have  been  redeemed,  and  it  will 
be  instructed  to  replenish  the  fund  to  that  extent. 
When  this  has  been  done,  the  notes  are  forwarded  to 
San  Francisco  to  be  reissued.  The  Treasury,  there- 
fore, acts  as  a  sort  of  clearing  house  for  the  note  issues 
of  the  country. 

National  Notes  as  Currency  —  From  the  point  of  view 
of  security,  both  ultimate  and  immediate,  therefore,  the 
National  bank  notes  must  be  considered  as  perfectly 
satisfactory.  But  there  is  a  further  difficulty  which 
was  not  so  successfully  met.  In  the  previous  chapter 
it  was  pointed  out  that  the  bank  notes  of  a  country 
formed  the  principal  part  of  the  elastic  money  ma- 
terial. If  this  elastic  currency  is  to  be  satisfactory  for 
the  commercial  needs  of  the  country,  it  should  expand 


212  AN    INTRODUCTION   TO   ECONOMICS 

when  the  needs  of  commerce  demand  more  currency ; 
that  is,  when  the  commercial  transactions  become 
heavier  and  more  numerous,  and  when  conditions 
change,  they  should  contract.  It  is  doubtful  if  any 
currency  system  ever  invented  has  perfectly  satisfied 
this  need.  But  the  National  bank  notes  certainly  did 
not  do  so.  This  was  due  to  the  nature  of  their  security. 

To  understand  this,  we  must  examine  the  nature  of 
profits  obtained  by  issuing  bank  notes,  on  the  security 
of  government  bonds.  First,  there  is  the  interest  paid 
by  the  government  on  the  bonds  purchased  by  the 
banks.  This  was  six  per  cent  at  first,  but  the  bulk  of 
the  existing  National  bank  notes  is  secured  by  two 
per  cent  bonds.  Secondly,  the  notes  are  lent  by  the 
banks  to  borrowers,  and  the  interest  charged  on  the 
loans  constitutes  a  part  of  the  profits.  Against  these 
profits  the  expenses  of  the  issue  must  be  counted. 
These  include  the  cost  of  issuing  the  notes,  the  federal 
tax  on  the  issue  (amounting  to  one  half  of  one  per 
cent  on  the  notes  secured  by  two  per  cent  bonds),  and 
some  other  expenses  with  which  we  need  not  deal. 
Subtracting  these  expenses  from  the  gross  profits,  we 
obtain  the  net  profits  on  the  issue. 

Perverse  Elasticity  —  According  to  a  calculation 
made  recently  the  net  profits  made  by  a  bank  note 
issue,  over  and  above  the  interest  received  on  loans 
made  (which  would  be  received  if  cash  had  been  lent 
instead  of  notes)  amounted  to  about  1.2  per  cent. 
This  is  a  small  amount,  but  it  becomes  important 
when  business  is  slack.  Hence,  in  times  of  depression 
when  it  is  important  that  the  banks,  like  every  other 
business,  must  make  every  effort  to  secure  profits,  note 


THE  AMERICAN  BANKING  SYSTEM  213 

issues  are  increased  in  order  to  gain  this  extra  interest. 
This  means,  therefore,  an  increased  issue  of  notes. 
But  the  very  fact  that  conditions-  are  depressed  is 
evidence  itself  of  a  smaller  need  for  currency.  So,  in- 
stead of  the  currency  being  reduced  as  it  should  be,  it 
is  increased. 

Again,  when  times  are  good  and  business  is  brisk, 
securities  appreciate  in  value,  and  it  may  be  profitable 
for  the  banks  to  sell  their  bonds  to  obtain  the  profit 
due  to  a  sale  at  a  higher  price  than  was  paid  for  the 
bonds.  But  the  bonds  cannot  be  sold  without  retiring 
the  currency  issued  upon  that  security.  Hence,  the 
tendency  is  to  sell  the  bonds  and  retire  currency  just 
at  the  period  when  business  conditions  suggest  the 
advisability  of  increasing  the  currency.  We  may  say, 
then,  that  National  bank  notes  are  not  inelastic  but 
perversely  elastic,  expanding  when  they  should  con- 
tract, and  contracting  when  they  should  expand. 

In  spite  of  this  very  grave  defect,  however,  the 
National  bank  notes  have  proved  to  be  infinitely  better 
than  the  wild  issues  which  preceded  them.  We  no 
longer  find  merchants  making  mathematical  computa- 
tions of  the  value  of  the  notes  received  in  payment  for 
goods,  on  the  basis  of  published  schedules  of  varying  cash 
values.  The  currency  is  sound,  but  not  satisfactory. 

The  Reserve  System  —  We  must  now  turn  to  the 
reserve  system  under  the  National  Banking  Act.  Of 
this  we  may  say  the  same  that  has  been  already  said 
in  regard  to  the  National  bank  notes  —  it  is  a  great 
improvement  over  the  older  system,  or  lack  of  system, 
but  it  has,  nevertheless,  grave  disadvantages.  The 
question  first  arises  as  to  the  advisability  of  legal 


214  AN   INTRODUCTION   TO   ECONOMICS 

control  of  the  amount  of  reserves.  It  has  often  been 
argued  that  the  bankers  themselves  are  the  best  judges 
of  the  amount  of  reserves  necessary  for  the  adequate 
protection  of  the  depositors.  There  is  a  very  large 
amount  of  trutli  in  this  contention,  but  the  answer  to 
the  argument  is  a  complete  justification  of  the  system. 
The  only  way  in  which  one  can  test  the  truth  of  the 
statement  of  the  banker's  ability  to  judge  of  reserves  is 
by  experience.  In  some  countries  (as  in  England,  for 
example),  experience  has  shown  that  if  the  decision  as 
to  the  amount  of  reserves  against  deposits  is  left  to  the 
bankers,  the  margin  of  safety  will  seldom  be  over- 
stepped. But  American  business  men  claim  that 
English  bankers  are  unprogressive  and  that  they  are 
too  .unwilling  to  take  a  chance.  The  last  criticism 
cannot  be  urged  against  American  bankers.  On  the 
contrary  it  may  be  said  that  the  early  bankers  in  the 
United  States  were  too  willing  to  take  chances. 

This  is  not  to  be  wondered  at.  They  lived  in  a  new 
land,  whose  constantly  unfolding  promises  of  immense 
riches  provided  a  continual  incentive  to  new  enter- 
prises. It  could  hardly  ever  be  foreseen  whether  a 
new  enterprise  would  be  a  huge  success  or  an  equally 
colossal  failure.  Optimism  abounded  and  the  bankers 
shared  in  the  general  belief  in  almost  impossible  prog- 
ress. The  result  was  a  strong  tendency  to  extend  credit 
beyond  sound  limits  and  thus  leave  depositors  in- 
adequately secured.  As  a  first  step  towards  rendering 
the  banking  system  sound,  therefore,  the  government 
had  to  take  the  decision  as  to  the  amount  of  reserve  to 
be  kept  out  of  the  hands  of  the  bankers,  and  lay  down 
a  minimum  below  which  they  must  not  fall. 


THE  AMERICAN  BANKING  SYSTEM  215 

Defects  of  the  System  —  Having  decided  upon  the 
minimum,  the  next  step  in  the  process  of  establishing 
the  system  was  to  direct  the  manner  in  which  the  re- 
serves should  be  kept.  It  is  against  this  method 
adopted  under  the  National  Banking  Act  that  most 
of  the  criticisms  have  been  aimed.  Broadly  speaking, 
the  reserves  may  be  divided  into  two  classes.  There 
are  first,  the  cash  reserves  held  in  the  vaults  of  the 
individual  banks.  Secondly,  there  are  the  reserves 
deposited  in  the  reserve  cities  and  central  reserve 
cities.  To  consider  first  the  cash  reserves  we  may 
use  the  simile  suggested  by  one  of  the  most  important 
framers  of  the  Federal  Reserve  Act.  Suppose  the  fire 
protection  system  in  a  big  department  store  were  to  con- 
sist of  fire  buckets,  one  or  two  buckets  being  placed  in 
each  room.  And  suppose,  further,  that  in  case  of  a 
fire  starting  in  one  room  of  the  building,  the  only  water 
supply  available  should  be  the  two  buckets  in  that 
room,  the  other  buckets  being  used  only  when  the  fire 
had  spread  to  the  room  in  which  they  were  situated. 
In  such  a  case  every  one  would  admit  that  the  fire 
protection  was  ridiculously  inadequate,  even  if  tht 
total  water  in  all  the  buckets  were  ample  to  extinguish  a 
large  fire.  Yet  this  is  what  happens  under  the  cash 
reserve  system  in  the  individual  banks.  Each  bank 
in  time  of  crisis  hangs  on  to  its  little  hoard  of  cash  for 
the  protection  of  its  own  creditors.  In  every  crisis 
this  protection  has  been  inadequate,  although  the  total 
cash  resources  of  all  the  banks,  properly  applied,  would 
have  met  all  the  needs. 

But,  it  may  be  said,  how  does  the  deposited  reserve 
affect  the  situation?  This  brings  us  to  another  con- 


216  AN  INTRODUCTION  TO  ECONOMICS 

sideration.  In  the  first  case  we  are  not  sure  that  the 
deposited  reserves  actually  exist.  Suppose  a  country 
bank  has  $50,000  of  deposited  reserves  in  a  New  York 
National  bank.  It  is  constantly  drawing  upon  that 
reserve  by  selling  drafts  on  New  York.  That  is,  the 
merchants  in  the  town  in  which  that  country  bank  is 
situated  in  making  payments  to  New  York  buy  drafts 
from  the  bank.  These  drafts  are  nothing  more  nor 
less  than  checks  drawn  by  that  bank  upon  its  deposit 
account  with  the  New  York  institution.  As  fast  as  it 
draws  those  checks,  and  thus  diminishes  the  deposit 
credit,  it  must  build  up  the  deposits  to  maintain  the 
reserve  amount.  The  deposits  are  renewed  by  paying 
into  the  New  York  bank  checks  which  have  been  drawn 
upon  some  New  York  institution  and  paid  into  the 
country  bank  in  question.  These  checks  represent 
amounts  paid  by  New  York  purchasers  of  goods  sold 
by  merchants  living  in  the  neighborhood  of  the  country 
bank.  Now  it  has  been  the  habit  of  the  country  banks 
to  consider  the  deposits  as  made  as  soon  as  the  checks 
have  been  put  in  the  mail  box.  The  New  York  bank, 
however,  would  not  credit  the  deposit  account  until  it 
had  received  the  checks,  and  it  is  possible  that  an 
interval  of  several  days  might  elapse  before  the  checks 
actually  arrived.  We  have,  therefore,  two  different 
statements  as  to  the  amount  of  reserve  for  this  par- 
ticular country  bank.  Let  us  assume  that  the  $50,000 
has  been  reduced  by  half.  The  balance  is  placed  in 
the  mail  box  and,  according  to  the  accounts  kept  in 
the  country  bank,  the  deposited  reserve  is  now  back 
again  at  $50,000.  But  the  figures  for  that  same  re- 
serve, if  taken  from  the  New  York  bank,  would  show 


THE  AMERICAN  BANKING  SYSTEM  217 

only  a  reserve  of  $25,000  during  the  interval  necessary 
for  the  transmission  of  the  new  deposits. 

It  is,  therefore,  doubtful  if  the  deposited  reserves 
are  anything  approaching  the  amount  shown  on  the 
books  of  the  depositing  banks.  If,  however,  we  admit 
the  existence  of  the  deposits,  we  must  also  consider  the 
fact  of  their  availability.  It  is  essential  that  these 
deposited  reserves  be  withdrawable  on  demand.  Con- 
sequently the  banks  which  hold  the  reserves  must  so 
lend  out  the  money  that  they  can  call  the  loans  at  any 
time.  If  they  lend  the  money  out  on  even  ordinary 
commercial  terms  of  fifteen,  thirty,  or  sixty  days,  it  is 
quite  conceivable  that  they  could  not  control  the  funds 
in  case  of  a  sudden  demand  for  withdrawal.  This  fact, 
in  its  turn,  limits  the  nature  of  the  loan  transactions, 
practically  to  one  class  —  the  stock  exchange  call  loan. 

The  Call  Loan  System  —  In  ordinary  stock  exchange 
transactions,  the  buyer  of  shares  does  not  pay  the  whole 
of  the  sum  for  the  purchase  himself.  He  pays  a  margin, 
amounting,  let  us  say,  to  ten  per  cent.  The  broker 
negotiates  a  loan  with  the  bank  on  the  security  of  the 
shares.  In  the  case  of  a  loan  of  $100,000  the  bank  will 
probably  require  shares  to  the  market  value  of  at  least 
$110,000.  The  difference  is  to  protect  the  bank  against 
a  possible  fall  in  the  value  of  the  security.  In  case  the 
loan  is  defaulted,  the  bank  has  the  right  to  sell  the 
security  and  it  must  be  sure  that  the  security  will 
realize  sufficient  to  pay  for  the  amount  of  money  orig- 
inally loaned,  together  with  the  expenses  of  the  trans- 
action. These  loans  are  made  "  at  call."  That  is, 
the  bank  has  the  right  to  ask  for  the  payment  of  loan 
at  any  time.  Thus,  the  deposited  reserves  of  the 


218  AN   INTRODUCTION   TO   ECONOMICS 

country  are  dependent,  not  upon  the  commercial  se- 
curity of  the  country,  but  upon  the  stability  of  the 
stock  market,  whose  operations  are  more  largely  specu- 
lative than  those  of  any  other  body. 

In  normal  times  there  is  no  doubt  that  the  reserve 
system  worked  fairly  satisfactorily.  But  a  good  re- 
serve system  should  not  be  dependent  upon  normal 
conditions.  We  do  not  ask  for  a  fire  protection  sys- 
tem that  works  satisfactorily  as  long  as  the  only  fires 
that  occur  consist  of  the  burning  of  waste-paper 
baskets.  What  is  wanted  is  one  which  will  take  care 
of  real  fires.  So  in  the  case  of  a  reserve  system  it 
must  be  judged  by  what  it  will  do  in  times  of  crisis. 
And  it  is  just  in  this  respect  that  the  National  bank 
reserve  system  fails. 

Reserves  during  Crisis  —  Consider  what  happens 
in  a  crisis.  Whether  that  crisis  be  caused  by  a  stock 
exchange  panic  (which  may  be  due  to  the  work  of 
manipulators)  or  by  general  business  depression,  the 
effect  is  the  same.  The  prices  of  stocks  fall.  Now  as 
soon  as  there  are  indications  of  the  approach  of  a  crisis, 
the  banks  require  to  increase  their  store  of  cash  re- 
serves. To  do  this,  they  must  call  for  the  return  of 
their  deposited  reserves.  In  order  to  repay  the  re- 
serves, the  central  reserve  city  banks  must  call  their 
loans.  In  order  to  repay  these  loans,  it  is  necessary 
for  the  brokers  to  sell  their  stocks.  This  means,  how- 
ever, that  the  market  is  flooded  with  selling  orders, 
with  a  consequent  rapid  and  steady  fall  in  prices. 
Some  of  the  brokers  are  unable  to  meet  their  obligations. 
The  banks,  therefore,  must  sell  the  deposited  stocks 
themselves.  This  in  its  turn  increases  the  amount  of 


THE    AMERICAN    BANKING    SYSTEM  219 

selling  orders  and  still  further  depresses  the  price  of 
the  stocks.  The  margin  of  security  (i.e.,  the  amount 
by  which  the  security  exceeded  the  amount  of  the 
loan)  is  soon  wiped  out  and  the  stocks  fall  farther. 
Even  if  the  banks  can  sell  the  stock,  it  is  at  a  loss. 
The  funds,  therefore,  are  simply  not  available. 

In  a  crisis  the  result  of  this  reserve  system  is  that 
the  only  reserves  which  are  really  available  for  use 
are  the  cash  reserves  in  the  vaults  of  the  individual 
banks.  To  these  cash  reserves,  the  banks  in  the 
soundest  condition  hold  on  tenaciously.  Those  which 
are  weaker  find  them  quite  insufficient,  and  so  are  com- 
pelled to  suspend  payments  in  order  that  their  de- 
positors may  share  equally  in  the  total  resources  of 
the  institution,  and  so  equalize  the  loss. 

The  account  given  above  is  not  theoretical  only. 
It  represents  what  has  happened  time  and  again  in 
American  commercial  history.  The  greatest  panic 
of  the  last  hundred  years  occurred  in  1907.  The 
results  of  the  weakness  of  the  reserve  system  were  then 
made  so  obvious  that  some  improvement  was  seen  to 
be  absolutely  essential.  Hence  from  that  year  until 
1913  investigations  were  made  as  to  the  best  possible 
solution  of  the  difficulty,  and  in  1913  Congress  passed 
the  Federal  Reserve  Act.  How  this  new  Act  attempts 
to  solve  the  problems  arising  out  of  the  National  bank- 
ing system  will  be  considered  in  the  next  chapter. 


CHAPTER  XVII 

THE    AMERICAN    BANKING  SYSTEM    (continued) 
THE  FEDERAL  RESERVE  BANKS 

We  have  seen  in  the  previous  chapter  that  the 
chief  faults  of  the  National  banking  system  lay  in 
the  methods  adopted  for  securing  a  sound  currency 
and  in  the  manner  of  keeping  reserves.  It  was  the 
task  of  those  who  framed  the  Federal  Reserve  Act 
to  remedy  those  faults.  In  order  to  understand  the 
remedies  enacted  it  will  be  necessary  to  anticipate 
a  discussion  which  will  be  dealt  with  more  fully  in  a 
later  chapter. 

Control  of  Reserves  by  Individual  Banks  —  The  re- 
serves act  as  a  sort  of  last  line  of  defense  in  a  panic. 
If  they  do  not  remain  strong  enough  to  satisfy  the 
demands  for  return  of  deposits,  nothing  is  left  but 
suspension  and  failure.  Before  the  necessity  of  draw- 
ing upon  reserves  appears,  however,  banks  can  obtain 
funds  in  several  ways.  They  can  stop  lending  money, 
for  instance.  If  there  is  time  available  for  collecting 
funds  before  the  demands  are  too  great,  this  method 
is  bound  to  build  up  funds.  Let  us  see  how  this 
occurs.  The  bank  profits  depend  upon  the  interest 
received  for  loans.  But  loans  are  not  indefinite. 
They  are  always  made  for  a  specified  time  or  else 
at  call.  If  the  bank  stops  lending  money,  therefore, 
220 


THE  AMERICAN  BANKING  SYSTEM  221 

it  has  only  to  await  the  maturity  of  the  loans  already 
made  for  the  funds  to  begin  to  accumulate.  Some 
will  mature  almost  immediately,  others  more  slowly, 
but  gradually  all  will  mature,  and  if  the  loans  have 
been  carefully  made,  the  bank  ultimately  will  have 
all  of  its  funds  intact. 

A  sudden  stoppage  of  loans,  however,  is  bad  from 
several  different  points  of  view.  In  the  first  place 
it  is  an  indication  of  weakness  on  the  part  of  the  bank. 
Quite  probably,  therefore,  it  will  bring  about  the 
very  demands  that  it  purposes  to  avoid.  In  the 
second  place,  it  will  result  in  serious  inconvenience 
to  business  men  who  have  been  relying  upon  the  possi- 
bility of  obtaining  loans  for  their  commercial  purposes. 
As  we  shall  see  later  on,  business  is  carried  on  mainly 
with  borrowed  money  and  a  sudden  stoppage  of  loans 
means  a  consequent  sudden  stoppage  of  business. 
Hence,  from  the  point  of  view  of  the  business  man, 
such  a  sudden  cessation  of  the  power  to  borrow  is  to 
be  avoided  if  it  is  at  all  possible. 

Use  of  the  Discount  Rate  —  Instead  of  a  sudden 
stoppage,  however,  the  stoppage  may  be  more  gradual. 
This  may  be  secured  by  raising  the  rate  of  discount. 
Suppose  there  are  two  men  each  of  whom  has  an  oppor- 
tunity to  make  profitable  use  of  a  certain  amount  of 
capital,  one  expecting  to  gain  seven  per  cent  on  the 
use  of  the  capital  and  the  other  eight  per  cent.  Now 
suppose,  further,  that  each  will  borrow  capital  for 
the  purpose  of  his  transaction  if  he  can  secure  a  net 
return  of  four  per  cent.  Finally'  let  us  suppose  that 
the  rate  of  discount  is  three  per  cent.  This  being 
the  case,  each  can  borrow  the  necessary  capital, 


222  AN  INTRODUCTION  TO  ECONOMICS 

paying  three  per  cent  for  its  use,  one  making  a  net 
profit  of  four  per  cent,  and  the  other  five.  Now  sup- 
pose the  discount  rate  is  raised  to  four  per  cent.  In 
this  case  the  man  whose  transaction  will  make  a  gross 
profit  of  seven  per  cent  finds  that  if  he  borrows,  his 
net  returns  will  only  be  three  per  cent.  By  our  hy- 
pothesis, however,  that  is  too  small  a  return  to  justify 
borrowing  the  capital.  Hence  he  will  not  borrow. 
The  other  man,  however,  can  still  borrow  and  make 
his  net  profit  of  four  per  cent.  The  result  of  the  rise 
in  the  discount  rate,  therefore,  is  to  prevent  one  man 
from  borrowing,  without  actually  prohibiting  him. 
One  loan  is  made  instead  of  two.  This  amounts,  of 
course,  to  a  gradual  cessation  of  lending. 

From  the  business  point  of  view,  this  means  that 
the  more  profitable  investment  is  carried  out  and  the 
less  profitable  prevented.  It  is  assumed  that  the 
more  profitable  is  that  one  which  is  most  required  by 
the  community,  and  therefore,  while  there  is  a  certain 
amount  of  restriction  in  business,  that  which  the 
community  feels  is  more  valuable  is  maintained  and 
only  the  less  valuable  elements  are  dropped. 

This  last  argument  must,  of  course,  be  interpreted 
very  broadly,  for  there  are  many  circumstances  to 
be  considered  in  estimating  the  value  of  a  transaction 
to  the  public,  besides  the  price  the  public  is  willing 
to  pay. 

In  each  of  the  foregoing  arguments,  however,  we 
have  assumed  that  all  the  banks  were  affected  equally. 
This  is  seldom  the  case,  however.  There  are  times 
when  one  bank  has  opportunities  of  making  satis- 
factory loans  to  a  much  greater  extent  than  others. 


THE  AMERICAN  BANKING  SYSTEM  223 

Hence,  we  can  often  find  instances  where  one  bank  in 
a  particular  district  is  compelled  to  refuse  sound 
loans,  while  in  another  district  there  are  banks  which 
cannot  find  sufficient  loans  to  employ  their  capital. 

Rediscounts  —  The  remedy  in  these  cases  is  simple. 
The  bank  which  has  too  many  loans  on  hand  may  take 
some  of  the  notes  which  it  has  already  discounted 
but  which  are  not  yet  mature,  and  discount  them 
again.  Suppose  the  First  National  Bank  of  Chicago 
has  opportunities  for  more  loans  than  it  has  available 
funds  to  supply.  The  reason  it  has  no  funds  is  obvi- 
ously because  it  has  already  lent  out  its  funds.  The 
evidences  of  indebtedness,  in  the  shape  of  discounted 
notes,  drafts,  etc.,  are  still  in  the  hands  of  the  banks, 
and  presumably  will  remain  there  until  the  loans 
mature.  At  the  same  time  let  us  suppose  that  the 
Wells  Fargo  Nevada  National  Bank  of  San  Francisco 
has  funds  for  which  there  are  no  borrowers.  There 
is  nothing  to  prevent  the  First  National  of  Chicago 
from  discounting  some  of  its  notes  with  the  Wells 
Fargo  Nevada  Bank.  By  so  doing,  the  Chicago 
bank  is  able  to  satisfy  its  clients  by  means  of  the  funds 
obtained,  while  the  San  Francisco  bank  has  employed 
some  of  its  surplus  funds.  This  process  is  called 
"  rediscounting."  For  some  reason  the  process  has 
not  recommended  itself  to  business  men  in  America 
until  recent  years.  They  have  assumed  that  a  bank 
which  rediscounts  its  "  paper  "  is  in  a  weak  condition. 
There  is  nothing,  however,  to  justify  that  assumption. 

One  of  the  great  difficulties  in  the  way  of  a  satis- 
factory development  of  the  system  of  rediscounting 
has  been  the  lack  of  facility  for  bringing  idle  capital 


224  AN  INTRODUCTION   TO   ECONOMICS 

to  the  place  where  it  is  needed.  That  is,  in  other 
words,  there  has  been  no  "rediscount  market."  Had 
there  been  such  a  market,  it  is  quite  possible  that  the 
panics  of  the  nineteenth  century  would  not  have 
been  so  severe  as  they  were.  At  any  rate,  it  may  be 
remarked  that  nowhere  in  Europe,  where  the  redis- 
count system  is  very  highly  developed,  have  panics 
been  so  severe  as  they  have  been  in  America. 

The  Federal  Reserve  Act  —  With  this  as  preface, 
we  may  now  turn  to  the  actual  provisions  of  the  Federal 
Reserve  Act.  The  Act  is  the  result  of  a  careful  exami- 
nation of  the  methods  of  banking  in  all  the  civilized 
countries.  What  has  seemed  adaptable  to  American 
circumstances  and  advisable  from  the  point  of  view 
of  American  needs  has  been  utilized  in  framing  the 
Act.  It  starts  out  with  an  attempt  at  unifying  the 
system.  At  the  head  of  the  system  stands  the  Federal 
Reserve  Board.  This  board  consists  of  seven  mem- 
bers, including  the  Secretary  of  the  Treasury  and  the 
Comptroller  of  the  Currency.  The  other  five  members 
are  appointed  by  the  President.  The  first  duty  of 
this  board  was  to  divide  the  country  into  twelve  dis- 
tricts, called  Federal  Reserve  districts.  In  each  of 
these  districts  a  Federal  Reserve  bank  was  established. 
The  banks,  however,  although  established  by  the 
federal  government,  do  not  belong  to  the  govern- 
ment. Each  National  bank  was  compelled,  under 
a  penalty  of  losing  its  charter  if  it  refused,  to  subscribe 
towards  the  capital  of  the  Federal  Reserve  bank  a  sum 
amounting  to  six  per  cent  of  its  capital  and  surplus. 
The  directors  of  the  banks  are  divided  into  three  classes. 
In  the  first  class  are  thos^e  who  are  appointed  by  the 


THE  AMERICAN  BANKING  SYSTEM  225 

Federal  Reserve  Board.  These  are  three  in  number 
and  include  the  president  and  vice-president.  These 
directors  act  as  representatives  of  the  board,  so  that 
the  central  control  is  well  established.  Another  three 
of  the  directors  must  be  men  engaged  in  banking 
business.  The  remaining  three  must  not  be  engaged 
in  any  banking  business,  but  must  be  representative 
business  men  of  the  community  in  which  the  bank  is 
situated.  The  manner  of  electing  the  six  local  direc- 
tors, as  we  may  call  them,  is  worth  explaining.  The 
banks  in  the  Federal  Reserve  district  which  are 
members  of  the  Federal  Reserve  system,  that  is,  all 
the  National  banks  in  the  district  and  those  other  banks 
and  trust  companies  which  have  become  members 
by  complying  with  the  necessary  conditions,  are  listed 
in  order  of  their  capital.  The  list  is  then  divided  into 
three  parts,  each  part  containing  the  same  number  of 
banks.  The  first  group  has  the  privilege  of  electing 
one  banker  as  a  director,  and  one  business  man.  The 
second  and  third  have  the  same  privilege.  The  reason 
for  this  mode  of  election  is  to  insure  the  representation 
on  the  directorate  of  the  Federal  Reserve  bank  of  the 
small  and  medium-sized  banks  as  well  as  of  the  banks 
with  large  capital. 

The  profits  of  the  bank  are  apportioned  as  under 
any  other  form  of  corporate  organization,  but  divi- 
dends are  limited  to  six  per  cent  of  the  capital.  If  the 
profits  earned  are  in  excess  of  six  per  cent,  the  differ- 
ence goes  to  the  government. 

The  Reserve  System  —  So  much  for  the  organiza- 
tion. We  must  now  consider  the  principles  upon 
which  the  system  works,  and  we  shall  deal  first  with 


226  AN  INTRODUCTION   TO   ECONOMICS 

the  reserves.  It  will  be  remembered  that  the  chief 
fault  in  the  reserve  system  under  the  National  Bank- 
ing Act  was  that  the  reserves  were  scattered  through- 
out the  country  as  far  as  the  cash  was  concerned,  and 
that  the  deposited  reserves  were  concentrated  in  the 
New  York  banks,  where  they  were  almost  invariably 
loaned  out  on  call  and  were  therefore  dependent  upon 
the  speculative  activities  rather  than  the  purely 
commercial. 

The  Federal  Reserve  Act,  as  it  is  now,  has  changed 
somewhat  from  its  original  form,  and  there  is  no  reason 
why  we  should  spend  time  over  the  initial  stages  of 
development.  Under  the  present  form  of  the  Act, 
the  whole  basis  of  the  reserves  has  been  changed.  In 
the  first  place  a  distinction  has  been  made  between 
time  and  demand  deposits.  It  is  realized  that  when 
a  banker  may  claim  a  certain  amount  of  notice  before 
being  compelled  to  refund  deposits,  he  does  not  need 
to  maintain  so  large  a  reserve  as  if  the  deposits  were 
withdrawable  on  demand.  A  decision  had  to  be  made, 
however,  as  to  the  exact  meaning  of  the  term  time 
deposit  as  distinguished  from  demand.  The  dis- 
tinction is  bound  to  be  arbitrary,  of  course,  but  the 
Federal  Reserve  Board  has  laid  it  down  that  deposits 
which  a  bank  accepts  on  condition  that  it  may  exact 
thirty  days'  or  more  notice  before  refunding,  are  con- 
sidered as  time  deposits.  Those  which  may  be  with- 
drawn with  less  than  thirty  days'  notice  are  demand 
deposits. 

The  old  nomenclature  of  Central  Reserve  Cities, 
Reserve  Cities,  and  Country  Banks  has  been  retained, 
but  a  change  has  been  made  in  the  proportions  of 


THE   AMERICAN   BANKING   SYSTEM  227 

reserve  against  deposits.  In  central  reserve  cities 
a  reserve  of  thirteen  per  cent  must  be  maintained 
against  demand  deposits.  In  reserve  cities  the  reserve 
minimum  is  ten  per  cent,  while  in  country  banks  a 
minimum  reserve  of  seven  per  cent  is  required  against 
demand  deposits.  The  proportion  of  reserve  against 
time  deposits  is  the  same  for  all  three  classes,  three 
per  cent.  A  vital  difference  in  the  method  of  carrying 
the  reserves  must  be  noted,  however.  Only  sums  on 
demand  deposit  with  a  Federal  Reserve  bank  may  be 
counted  as  reserve.  Cash  in  vaults  is  no  longer  recog- 
nized as  a  method  of  maintaining  reserves.  The 
Federal  Reserve  bank  must  maintain  a  cash  reserve 
of  thirty-five  per  cent  against  its  deposits. 

It  will  be  noted  that  under  this  system  the  reserves 
of  the  country  are  centralized,  but  centralized  in  dis- 
tricts. Each  Federal  Reserve  bank  is  the  custodian 
of  the  reserves  for  the  whole  of  the  district  in  which 
it  is  situated  (excepting,  of  course,  the  reserves  of 
non-member  banks).  Now  the  business  done  by  the 
Federal  Reserve  banks  consists  mainly  in  the  buying  of 
commercial  paper.  That  is,  the  Federal  Reserve  banks 
are  dependent  upon  commerce  rather  than  upon  specu- 
lation. This  in  itself  is  a  valuable  improvement. 

The  centralization  of  reserves,  on  a  proper  basis  of 
commercial  activity,  remedies  the  defects  which  we 
saw  in  dealing  with  the  National  banks.  We  may 
no  longer  liken  the  reserve  system  to  a  fire  system 
consisting  of  individual  buckets  only  available  in  the 
rooms  in  which  they  are  placed.  Now  it  may  be 
compared  with  a  building  in  which  there  is  a  central 
tank,  with  pipes  leading  to  all  the  rooms,  the  whole 


228  AN  INTRODUCTION   TO   ECONOMICS 

force  being  available  for  a  fire  which  breaks  out  in  a 
single  room.  The  tank,  too, .if  we  may  continue  the 
simile,  is  always  full.  The  reserves  in  the  Federal 
Reserve  bank  are  real  reserves  and  are  available 
when  required. 

Rediscount  Market  —  It  is  not  necessary  for  the 
banks  always  to  draw  upon  their  reserves  when  they 
are  called  upon  to  refund  money.  The  Federal  Reserve 
system  provides  what  was  lacking  in  the  older  system, 
a  rediscount  market.  Commercial  paper  may  be 
rediscounted  in  the  Federal  Reserve  bank  provided 
it  is  not  of  longer  maturity  than  ninety  days.  The 
expression  "  commercial  paper  "  needs  some  definition. 
The  primary  transaction  upon  which  all  commerce 
rests  is  the  purchase  and  sale  of  goods.  When  a 
merchant  sells  goods  it  is  customary  for  a  certain 
amount  of  credit  to  be  given  the  customer,  the  length 
of  credit  varying  with  the  nature  of  the  business  and 
the  individual  conditions  of  the  transaction.  Now 
the  seller  may  not  wish  to  lose  the  use  of  his  capital 
during  the  life  of  the  credit  period.  If  he  waits  until 
the  time  is  up  before  he  receives  his  money,  he  cannot 
make  any  use  of  that  money  during  the  intermediate 
period.  This  means  that  he  is  acting  as  a  banker 
to  his  customer  and  practically  lending  the  customer 
the  amount  due  for  the  length  of  the  credit  period. 

In  order  to  obtain  the  money  before  his  customer 
pays  for  the  goods,  he  negotiates  a  loan  with  the 
bank.  The  evidence  of  the  loan,  in  the  form  of  accepted 
draft  or  promissory  note,  is  termed  commercial  paper. 
The  varieties  of  the  forms  of  commercial  paper  need 
not  concern  us  here. 


THE   AMERICAN  BANKING  SYSTEM  229 

A  note  which  is  secured  by  the  deposit  of  "  col- 
lateral "  in  the  shape  of  stocks  and  bonds,  or  by  a 
real  estate  or  chattel  mortgage,  is  not  considered  com- 
mercial paper.  Hence  the  notes  which  a  stock  broker 
signs  when  he  obtains  a  loan  on  the  security  of  the 
bonds  which  he  deposits  with  the  bank  are  not  redis- 
countable  at  the  Federal  Reserve  bank. 

Now  let  us  suppose  that  a  certain  National  bank 
finds  its  reserves  in  the  Federal  Reserve  bank  are 
falling  close  to  the  minimum.  It  does  not  need  to 
call  in  its  loans,  or  to  stop  lending.  All  that  is  necessary 
is  that  the  bank  take  some  of  the  notes  discounted 
by  it  previously  and  rediscount  these  with  the  Federal 
Reserve  bank.  The  proceeds,  instead  of  being  received 
in  cash,  will  be  credited  to  the  deposit  account  of 
the  National  bank,  so  increasing  its  reserve  fund. 

Crises  and  Panics  —  Now  it  is  very  important  to 
realize  that  this  process  of  rediscounting  has  a  very 
great  influence  on  the  prevention  of  panics.  Panics 
rise  from  many  causes,  but  we  may  distinguish  two 
important  varieties.  In  the  first  place,  there  are 
panics  which  are  purely  the  result  of  stock  exchange 
movements  which  may  be  due  to  manipulations 
unconnected  with  the  commercial  prosperity  of  the 
country.  The  reserves,  as  we  have  seen,  are  not  con- 
nected with  stock  exchange  transactions.  The  more 
important  cause  of  panics  rests  with  the  fluctuations 
of  trade.  Suppose  a  manufacturer  sends  out  his  sales- 
man at  the  beginning  of  a  certain  year,  and  finds  that 
at  first  orders  come  in  slowly.  Little  by  little,  how- 
ever, the  orders  increase.  He  begins  to  work  his 
factory  at  full  pressure.  The  orders  continue  to  in- 


230  AN   INTRODUCTION    TO   ECONOMICS 

crease  in  number  and  size.  His  factory  works  over- 
time. In  order  to  obtain  plentiful  supplies  of  raw 
material,  he  obtains  loans  from  the  banks.  The 
banks,  seeing  that  business  conditions  are  good  and 
that  the  manufacturer  has  every  reason  to  suppose 
that  he  will  be  able  easily  to  sell  the  goods  he  makes, 
are  perfectly  willing  to  lend  the  sums  necessary.  The 
manufacturer,  with  this  additional  capital  at  his 
disposal,  increases  his  production.  There  comes  a 
time,  however,  when  the  orders  are  not  so  easily 
obtained,  and  he  must  encourage  sales  by  dropping 
prices  a  little.  But  he  is  only  one  of  many.  Other 
manufacturers  are  going  through  a  similar  experience. 
Hence  there  is  a  tendency  to  reduce  prices  all  round. 
Suddenly,  one  manufacturer  realizes  that  if  he  is 
to  repay  the  sums  he  has  borrowed,  he  must  sell  at  a 
loss.  The  market  has  become  overstocked  and  goods 
can  only  be  sold  at  a  sacrifice.  The  banks,  looking 
to  the  safety  of  their  funds,  begin  to  call  loans.  If 
the  credit  has  been  too  far  extended  there  is  every 
possibility  of  business  failures  and  a  commercial  panic. 
Under  the  former  system  of  banking,  the  difficulty 
was  to  know  exactly  when  credit  was  overextended, 
and  when  business  conditions  really  justified  increases 
in  credit.  Under  the  Federal  Reserve  system  there 
is  a  definite  commercial  pulse,  as  it  were,  which  can 
be  felt  from  day  to  day. 

The  Discount  Rate  —  The  Federal  Reserve  banks, 
as  we  have  said,  must  maintain  a  high  reserve  against 
their  own  deposits.  If  this  reserve  tends  to  fall  toward 
the  minimum,  obviously  rediscounts  cannot  be  con- 
tinued at  the  same  rate.  The  simplest  method  to  adopt 


THE   AMERICAN  BANKING  SYSTEM  231 

in  order  to  cut  down  the  amount  of  rediscounts  is 
to  raise  the  discount  rate.  Rediscounting  will  then 
be  resorted  to  only  by  banks  which:really  need  funds. 
Those  whose  needs  are  not  pressing  will  not  redis- 
count. But  the  raising  of  the  discount  rate  by  the 
Federal  Reserve  bank  is  the  signal  for  the  raising  of 
discount  rates  by  the  member  banks.  A  fall  in  the 
reserves  of  the  Federal  Reserve  bank,  therefore,  may 
be  regarded  as  a  sign  of  a  tendency  towards  over- 
extension  of  credits.  But  as  this  fall  is  seen  immedi- 
ately, steps  can  be  taken  to  curtail  credits  by  raising 
rates,  and  so  the  incipient  panic  is  checked. 

Currency  —  The  next  important  fault  in  the  Na- 
tional banking  system  is  the  nature  of  the  bank  note 
currency.  We  have  seen  that  this  currency  has  no 
relation  to  the  commercial  needs  of  the  country.  It 
is  based  on  the  security  of  bonds  deposited  with  the 
United  States  Treasury,  and  fluctuations  in  the  value 
of  the  bonds  affect  the  amount  of  notes  in  circulation. 
In  order  to  secure  a  satisfactory  currency,  it  is  necessary 
that  it  be  based  upon  the  needs  of  commerce,  increasing 
as  the  demands  for  currency  increase  and  decreasing 
as  the  demands  become  less. 

Federal  Reserve  Notes  —  Two  new  forms  of  cur- 
rency paper  are  issued  under  the  Federal  Reserve 
Act,  of  which  the  more  important  are  the  Federal 
Reserve  notes.  These  notes  are  based  principally 
upon  the  commercial  transactions  of  the  country. 
Let  us  suppose  that  a  merchant  requires  a  loan  from 
the  bank  of,  say  $10,000.  This  loan  is  for  the  purpose 
of  making  payments  in  small  amounts,  for  wages, 
petty  expenses,  and  so  forth.  To  obtain  the  loan  in 


232  AN  INTRODUCTION   TO   ECONOMICS 

the  form  of  a  deposit  credit  necessitates  the  payment 
of  the  wages,  and  so  forth,  by  check.  This  is  not  a 
satisfactory  methdd  in  many  places,  as  the  workmen 
who  receive  the  wages  are  not  in  the  habit  of  carrying 
bank  accounts.  It  is  much  more  convenient  to  receive 
the  money  in  the  form  of  bank  notes  or  government 
currency.  The  merchant,  therefore,  asks  for  the 
loan  in  the  form  of  bank  notes.  Now  it  is  quite  possible 
that  the  bank  has  not  the  requisite  amount  of  currency 
on  hand.  It  can  obtain  the  notes,  however,  by  redis- 
counting  the  merchant's  note  at  the  Federal  Reserve 
bank,  receiving  the  rediscount  payment  in  the  form 
of  Federal  Reserve  notes.  These  notes  are  secured 
by  a  gold  reserve  of  forty  per  cent  of  the  amount  issued 
and  by  the  commercial  paper  rediscounted. 

Of  the  forty  per  cent  of  gold,  the  Reserve  bank  can- 
not keep  more  than  thirty-five  per  cent  in  its  own 
vaults.  Five  per  cent  must  be  deposited  with  the 
Treasury  to  form  a  fund  for  the  redemption  of  out- 
standing notes. 

How  far  are  these  notes  an  improvement  over  the 
National  bank  notes?  To  answer  this  question  we 
must  look  at  the  system  from  the  points  of  view  of 
(a)  ultimate  security,  (b)  immediate  redemption, 
and  (c)  elasticity. 

In  regard  to  the  first  point,  ultimate  security,  it  can 
readily  be  seen  that  there  need  be  no  apprehension  on 
the  part  of  holders  as  to  the  security.  In  the  first 
place,  there  is  the  fact  that  at  least  forty  per  cent  of 
the  issue  is  definitely  -secured  by  gold.  The  remainder 
is  secured  by  commercial  paper.  We  must  examine, 
therefore,  the  value  of  such  paper  as  security.  The 


THE    AMERICAN    BANKING    SYSTEM  233 

commercial  paper  represents  actual  business  transac- 
tions involving  a  necessity  for  currency.  Before  the 
banker  makes  the  first  loan  he  will  scrutinize  the 
transaction  very  carefully  to  see  that  there  is  every 
likelihood  of  the  fund  for  repayment  being  accumu- 
lated during  the  life  of  the  note.  He  only  makes  the 
loan  when  he  is  satisfied  on  this  point.  This  means, 
then,  that  in  the  banker's  opinion,  a  sound  transac- 
tion in  commerce  is  under  way.  It  is  possible,  of 
course,  that  the  transaction  may  fail;  that  the  indi- 
vidual who  owes  the  money  may  not  be  able  to  pay 
at  maturity.  In  that  case,  the  banker  must  have 
recourse  to  the  resources  of  the  borrower.  The  actual 
proportion  of  defaults  on  commercial  notes  is,  however, 
very  small.  The  chances  of  failure  are  less  than  one 
tenth  of  one  per  cent,  i.e.,  less  than  one  in  a  thousand. 
But  the  note  is  secured  by  more  than  the  promise 
of  the  original  maker.  When  it  is  rediscounted  the 
member  bank  must  place  its  own  indorsement  on  the 
note.  The  Federal  Reserve  bank  is  therefore  secured 
by  the  promise  of  the  member  bank,  in  addition  to 
that  of  the  original  maker  of  the  note. 

This  reduces  the  possibilities  of  failure  to  a  minimum. 
As  far,  then,  as  ultimate  security  is  concerned,  we  may 
regard  the  Federal  Reserve  notes  as  being  perfectly 
satisfactory.  In  regard  to  the  immediate  redemption, 
the  same  method  is  adopted  as  under  the  National 
bank  system.  A  five  per  cent  redemption  fund,  in 
gold,  is  maintained  with  the  Treasury,  and  notes 
are  cleared  there  in  the  same  manner  as  are  the  National 
bank  notes. 

The  issue  of  the  Federal  Reserve  notes  is  controlled 


234  AN    INTRODUCTION  TO   ECONOMICS 

by  the  Federal  Reserve  Board,  through  its  repre- 
sentatives on  the  directorate  of  the  Federal  Reserve 
bank.  The  chairman  and  vice-chairman  of  the 
board  of  directors  are  known  respectively  as  the 
Reserve  Agent  and  Deputy-Reserve  Agent.  It  is 
their  duty  to  obtain  from  the  Federal  Reserve  Board 
the  Federal  Reserve  notes  and  to  issue  these  to  the 
Federal  Reserve  bank  as  required.  The  gold  and 
commercial  paper  which  secure  these  notes  are  placed 
in  the  care  of  the  Reserve  Agent,  who  must  always 
see  that  the  paper  is  of  the  kind  designated  by  the 
Board  as  suitable  for  security  and  that  the  gold  fund 
is  kept  up  to  the  minimum  required  by  the  Act. 

In  the  next  chapter  we  shall  consider  the  Federal 
Reserve  notes  from  the  point  of  view  of  an  elastic 
currency. 


CHAPTER  XVIII 

THE    FEDERAL    RESERVE    SYSTEM    (continued),    WITH 
A  NOTE  ON  THE  CANADIAN  BANKING  SYSTEM 

Elasticity  of  Currency  —  Let  us  imagine  a  transac- 
tion in  the  ordinary  business  of  commerce.  Suppose 
a  merchant  has  sold  $10,000  worth  of  goods  to  one 
of  his  customers  on  the  basis  of  thirty  days'  credit. 
The  customer  gives  his  note  at  thirty  days  in  payment. 
The  merchant  discounts  this  note  at  the  bank  in  order 
to  obtain  funds  for  the  payment  of  ordinary  current 
expenses  in  the  way  of  wages,  and  so  forth.  He  asks 
the  bank  for  cash  instead  of  deposit  credit.  In  order 
to  obtain  the  cash,  the  bank  rediscounts  the  note  with 
the  Federal  Reserve  bank  of  the  district  and  obtains 
Federal  Reserve  notes,  which  are  paid  over  to  the  mer- 
chant. The  note,  upon  which  the  loan  is  based,  is 
now  in  the  hands  of  the  reserve  agent  of  the  Federal 
Reserve  bank.  The  Federal  Reserve  notes  are  in 
general  circulation.  During  the  thirty  days,  which  is 
the  length  of  the  credit  period,  the  notes  are  continually 
passing  from  hand  to  hand.  The  customer,  however, 
is  gradually  selling  the  goods,  receiving  in  payment, 
we  may  suppose,  Federal  Reserve  notes,  which  he  de- 
posits with  his  bank. 

At  the  end  of  the  thirty  days,  when  the  note  is 
mature,  the  reserve  agent  calls  upon  the  bank  which 
indorsed  the  note  to  repay  the  loan.  Usually,  the 
235 


236  AN  INTRODUCTION   TO   ECONOMICS 

Federal  Reserve  bank  will  send  the  note  to  the  mem- 
ber bank  for  collection.  The  member  bank,  there- 
upon, sends  the  note  to  the  man  who  signed  it  origi- 
nally, that  is,  the  customer  who  has  been  selling 
the  goods  during  the  preceding  thirty  days.  He  pays 
the  amount  by  drawing  upon  the  money  he  has  de- 
posited in  his  bank.  This  money  is  represented,  we 
may  assume,  by  the  Federal  Reserve  notes  collected 
in  payment  for  the  goods.  In  turn  these  notes  are 
handed  to  the  bank,  which  then  turns  them  over  to 
the  Federal  Reserve  bank.  The  Reserve  bank,  there- 
fore, has  received  back  the  notes  which  it  issued  on 
the  security  of  the  commercial  paper,  and  this,  being 
paid,  is  now  canceled.  At  the  same  time,  the  Reserve 
notes  are  also  retired  from  circulation. 

To  sum  up  the  whole  transaction,  therefore,  we  may 
say  that  the  sale  of  the  $10,000  worth  of  goods  gave 
rise  to  the  provision  of  the  amount  of  currency  neces- 
sary to  finance  the  operation.  As  soon  as  the  sale 
is  consummated,  the  goods  in  the  hands  of  the  ultimate 
consumers,  and  the  payment  received,  the  currency 
which  was  issued  is  canceled. 

It  must  not  be  supposed,  of  course,  that  this  transac- 
tion represents  the  actual  facts  of  every  case.  Obvi- 
ously the  same  identical  notes  which  are  issued  by  the 
Federal  Reserve  bank  are  not  returned  for  final 
retirement.  The  actual  process  is  a  little  more  com- 
plicated, but  essentially,  the  description  given  above 
represents  the  facts.  With  every  issue  of  Federal 
Reserve  notes,  there  is  a  corresponding  amount  of 
commercial  paper.  With  every  cancellation,  by  pay- 
ment, of  such  commercial  paper,  there  is  a  correspond- 


THE  FEDERAL  RESERVE  SYSTEM  237 

ing  retirement  of  Federal  Reserve  notes.  This  answers 
the  criticism  which  has  been  leveled  at  the  system  by 
certain  English  writers  —  the  criticism  that  the  Federal 
Reserve  notes  represent  inflation  of  the  currency. 

It  must  now  be  obvious  that  the  issue  of  notes 
depends  upon  the  existence  of  a  commercial  transac- 
tion which  necessitates  the  currency,  and  that  as 
soon  as  the  commercial  transaction  is  completed  the 
notes  are  almost  automatically  retired.  The  system 
provides  an  elastic  currency  which  fluctuates  accord- 
ing to  the  needs  of  the  community.  The  only  point 
at  which  there  is  evidence  of  inflation  is  the  fact  that 
the  Federal  Reserve  notes  form  an  addition  to  the 
National  bank  circulation,  and  not  a  substitute  for 
it.  If  the  National  bank  circulation  is  left  untouched, 
then  it  would  appear  that  the  total  currency  is  in- 
creased by  just  the  amount  of  Federal  Reserve  notes 
which  are  in  circulation.  It  was  the  intention  of 
those  who  designed  the  Federal  Reserve  Act,  however, 
that  the  new  currency  should  be  a  substitute  for  the 
National  bank  notes,  and  not  an  addition.  Provisions 
had  to  be  made,  therefore,  for  the  retirement  of  at 
least  the  greater  part  of  the  National  bank  notes. 

Federal  Reserve  Bank  Notes  —  Now,  as  we  have 
already  seen,  the  National  bank  notes  are  secured 
by  the  deposit  of  United  States  Bonds.  We  have 
also  seen  that  one  of  the  provisions  of  the  National 
Banking  Act  compelled  all  National  banks  to  pur- 
chase a  certain  amount  of  government  bonds,  whether 
they  intended  to  issue  notes  or  not.  This  provision 
was  repealed  by  the  Federal  Reserve  Act  and  so  there 
is  no  reason  why  the  National  banks  should  issue  cur- 


238  AN  INTRODUCTION   TO   ECONOMICS 

rency.  The  currency  cannot  be  retired,  however, 
without  selling  the  bonds  which  act  as  security  for 
the  issue.  But  the  price  of  these  bonds  (which  are 
mainly  two  per  cent  bonds)  was  only  maintained 
at  par  because  of  the  demand  for  them  as  security 
for  note  issues.  Now  that  the  reason  for  this  demand 
has  ceased,  it  would  seem  that  the  bonds  would  fall 
to  their  normal  level  for  gilt-edged  securities  paying 
two  per  cent.  This  level  is  considerably  below  par. 
Therefore,  unless  a  special  market  is  provided  for  the 
sale  of  such  bonds,  the  banks  in  self-defense  will  be 
compelled  to  maintain  their  issues  until  the  maturity 
of  the  government  bonds,  for  if  they  sold  them,  they 
would  suffer  considerable  loss. 

The  Federal  Reserve  Act  provides  such  a  market 
in  the  following  manner  : 

Any  bank  which  wishes  to  retire  part  of  its  circulation 
may  sell  its  bonds  to  the  Federal  Reserve  Bank  at 
par.  The  Federal  Reserve  banks  are  compelled  to 
take  not  more  than  $25,000,000  of  these  bonds  each 
year.  The  total  bond  sales  are  proportioned  among 
the  twelve  Federal  Reserve  banks. 

It  might,  of  course,  involve  the  Federal  Reserve 
banks  in  considerable  loss  if  they  were  compelled  to 
purchase  bonds  to  this  extent  and  tie  up  their  capital. 
The  Act,  however,  provides  that,  if  they  think  fit, 
the  Federal  Reserve  banks  themselves  may  issue  cur- 
rency notes,  which  are  termed  Federal  Reserve  Bank 
notes,  to  distinguish  them  from  Federal  Reserve  notes, 
against  the  security  of  the  bonds  so  purchased.  If, 
however,  the  Federal  Reserve  banks  do  not  wish  to 
insure  currency  on  this  basis,  they  may  exchange  the 


THE  FEDERAL  RESERVE  SYSTEM  239 

bonds  for  three  per  cent  gold  bonds  without  the  priv- 
ilege of  issue.  The  extra  one  per  cent  compensates 
the  bank  for  the  loss  of  the  issue  privilege. 

The  gold  bonds  received  in  exchange  for  the  old 
two  per  cent  bonds  are  divided  into  two  classes.  Half 
of  them  mature  in  thirty  years.  The  other  half 
mature  in  one  year,  but  the  Treasury  has  the  right  to 
renew  them  from  year  to  year,  but  not  for  more  than 
thirty  years.  In  practice,  very  few  of  the  Federal 
Reserve  banks  have  issued  notes  based  on  the  bond 
security,  and  the  probability  is  that  by  the  end  of  the 
thirty-year  period  the  only  bank  notes  in  circulation 
will  be  the  Federal  Reserve  notes. 

Summary  —  We  are  now  in  a  position  to  sum  up 
the  effects  of  the  Federal  Reserve  Act.  It  has,  in 
the  first  place,  compromised  between  the  idea  of  a 
National  central  institution  and  the  entirely  unrelated 
institutions  which  preceded  it.  There  are  now  twelve 
banks  which  act  as  central  banks  for  the  different 
districts.  In  so  doing,  they  provide  a  sort  of  clearing 
house  for  country  checks  and  so  extend  the  clearing 
house  system  beyond  the  limits  of  the  cities.  Still 
further  to  extend  this  system,  the  Federal  Reserve 
Board  itself  acts  as  a  clearing  house  for  the  whole 
of  the  country. 

The  reserves  are  placed  upon  a  sounder  basis  and 
are  entirely  divorced  from  the  speculative  element 
in  finance.  They  are  based  upon  commercial  opera- 
tions entirely  and  this  eliminates  one  of  the  factors  in 
the  production  of  commercial  crises.  The  reserves  are 
more  economical  to  the  institutions  than  under  the 
old  system,  despite  the  fact  that  the  Federal  Reserve 


240  AN    INTRODUCTION   TO   ECONOMICS 

banks  do  not  pay  any  interest  upon  deposits,  while 
the  National  banks  were  in  the  habit  of  paying,  as  a 
rule,  two  per  cent  interest  upon  bankers'  deposits. 
To  illustrate  this,  let  us  consider  the  case  of  a  country 
bank  whose  deposits  amount  to  $100,000. 

Under  the  National  banking  system  the  reserves 
to  be  maintained  againstthis  amount  would  be  $15,000. 
Of  this  amount,  however,  $9,000  might  be  placed  on 
demand  deposit  with  a  National  bank  in  a  central 
reserve  city,  and  earn  two  per  cent.  The  cost  of 
keeping  reserves  may  be  estimated  as  the  amount 
which  the  reserves  would  earn  if  placed  out  at  interest 
at  the  prevailing  rate.  Let  us  suppose  that,  during 
the  year,  the  average  rate  of  interest  earned  is  five 
per  cent.  The  loss  of  interest  on  the  $6,000  cash 
reserve  would  be  $300.  As  the  $9,000  deposited 
reserves  would  earn  interest  at  the  rate  of  two  per 
cent,  the  net  loss  is  three  per  cent,  or  $270,  making 
a  total  net  loss  of  $57jO.  The  interest  earned  on  the 
balance  of  $85,000  deposits  would  be  $4,250. 

Now  under  the  Federal  Reserve  system,  the  first 
fact  to  be  noticed  is  that  a  distinction  is  made  between 
the  demand  and  time  deposits.  On  the  average,  a 
country  bank  has  twice  as  much  demand  deposits  as 
time.  To  be  on  the  safe  side,  let  us  suppose  that  the 
deposits  are  divided  into  seventy  per  cent  demand 
and  thirty  per  cent  time.  Against  the  time  deposits  a 
reserve  of  three  per  cent  is  maintained.  This  amounts 
to  $900,  the  loss  of  interest  on  which,  at  five  per  cent, 
amounts  to  $45.  Against  the  demand  deposits  a 
reserve  of  seven  per  cent  is  kept,  amounting,  in  this 
case,  to  $4,900.  The  loss  of  interest  on  this  sum 


THE  FEDERAL  RESERVE  SYSTEM  241 

amounts  to  $245,  making  a  total  net  loss  of  $290  as 
against  $570  under  the  National  banking  system. 
But  the  amount  of  earning  deposits  under  the  Federal 
Reserve  system  is  $94,200  as  against  $85,000  under 
the  National  banking  system.  This  means  a  possi- 
bility of  net  earning  of  $4,710  instead  of  $4,250. 

In  regard  to  economy  of  funds,  therefore,  the  Federal 
Reserve  system  has  very  considerable  advantage  over 
the  older  method. 

The  currency  system  is  much  improved  by  the  new 
Act.  Instead  of  a  currency  which  is,  in  spite  of  its 
soundness  as  far  as  par  value  is  concerned,  perversely 
elastic,  we  have  a  currency  which  is  equally  sound 
and  yet  directly  elastic,  in  that  it  comes  into  exist- 
ence only  when  commercial  transactions  demand  the 
additional  notes,  and  when  those  transactions  are 
completed,  the  currency  is  almost  automatically  re- 
tired. 

Perhaps  the  most  important  of  all  the  improvements, 
however,  lies  in  the  definite  establishment  of  a  redis- 
count market.  This  enables  the  Federal  Reserve 
Board  to  keep  its  finger  upon  the  commercial  pulse 
and  to  know  when  credit  conditions  are  becoming 
unduly  extended  long  before  that  extension  assumes 
dangerous  proportions. 

The  fact  that  the  Federal  Reserve  Board  may  defi- 
nitely stipulate  what  kind  of  paper  it  will  accept  for 
rediscount  purposes  renders  it  possible  to  educate 
business  men  into  the  use  of  the  most  satisfactory 
methods  of  financing  their  business. 

Finally  we  must  mention  the  method  of  control 
of  the  whole  of  the  member  banks.  In  the  case  of 


242  AN    INTRODUCTION   TO   ECONOMICS 

a  National  bank,  as  we  have  seen,  the  government 
provided  for  periodical  examination.  This  is  done 
also  under  the  Federal  Reserve  system,  but  the  exami- 
nations are  a  little  more  stringent.  Provision  is  made 
against  what  is  known  as  "  window  dressing."  Sup- 
pose a  bank  is  ordered  to  report  the  state  of  its  affairs 
on  the  sixth  of  June  and  receives  the  notice  a  month 
before  that  date.  In  the  interval  there  is  time  for 
the  bank  to  close  out  some  of  its  weaker  loans, 
strengthen  its  reserve,  examine  its  collateral,  and  see 
that  all  securities  represent  sound  values.  By  the 
time  the  date  of  the  report  arrives,  the  condition  of 
the  bank  is  such  that  it  will  present  a  very  favor- 
able report.  This  is  avoided  by  the  Federal  Re- 
serve Board  asking  for  reports  for  a  day  which  has 
already  passed.  Five  reports  are  to  be  made  each 
year  and  the  Board  may  ask  for  these  at  its  own 
convenience. 

There  is  also  an  examination  necessary  before  any 
new  bank  is  admitted  into  the  system,  in  order  that 
only  sound  institutions  shall  be  maintained. 

In  short,  the  United  States  has  now  a  banking  sys- 
tem which  will  compare  with  the  best  existing  any- 
where. It  is,  of  course,  not  perfect  but  it  represents 
a  wonderful  improvement  upon  that  which  preceded 
it.  As  to  its  actual  working,  the  system  has  been  in 
operation  for  too  short  a  time  to  pronounce  a  definite 
verdict,  but  it  may  be  said  that  up  to  the  present 
the  faults  which  have  developed  are  comparatively  in- 
significant and  the  system  has  stood  a  strain  which 
financial  institutions  are  very  seldom  called  upon  to 
stand. 


THE  FEDERAL  RESERVE  SYSTEM  243 

NOTE  ON  THE  CANADIAN  BANKING  SYSTEM 

The  banking  system  of  Canada  has  long  been  recog- 
nized as  exceptionally  strong.  It  differs  very  ma- 
terially from  that  of  the  United  States,  whether  we 
consider  the  National  banks  or  the  Federal  Reserve 
system.  Canada  has  no  great  central  bank,  but,  on 
the  other  hand,  it  does  not  have  a  great  number  of 
small,  or  comparatively  small  banks.  There  are 
about  thirty  banks  in  the  Dominion  which  have  received 
a  government  charter.  These  institutions  have  their 
headquarters  usually  in  the  city  from  which  they 
receive  their  name.  But  they  are  represented  through- 
out the  country  by  great  numbers  of  branches  all  in 
close  connection  with  the  parent  institution.  In  this 
way,  each  of  the  parent  banks  acts  as  a  sort  of  central 
institution  in  much  the  same  way  as  the  Federal 
Reserve  bank  acts  in  the  United  States. 

The  relation  is  even  closer,  however,  for  the  central 
bank  gives  very  close  supervision  to  the  acts  of  the 
branches,  controls  the  reserves,  and  distributes  the 
funds  where  they  will  do  the  most  good.  There  is 
no  reason  why  there  should  be  idle  funds  while  the 
business  of  the  community  shows  the  necessity  for 
loans  to  be  made.  If  business  is  dull  where  one 
branch  is  situated,  other  branches  can  make  use  of 
the  spare  funds.  From  the  point  of  view  of  account- 
ing, the  system  has  the  great  advantage  of  a  uniform 
method.  Hence  the  statistics  of  banking  are  in  a 
much  more  satisfactory  condition  than  they  are  in 
the  United  States,  although  under  the  new  organiza- 
tion in  this  country  a  much  closer  approach  to  stand- 


244  AN    INTRODUCTION   TO   ECONOMICS 

ardization  of  method  is  possible  now  than  under  the 
Did  banking  act. 

The  system  of  bank  examinations  in  Canada  is, 
or  perhaps  it  is  better  to  say  was,  much  more  strict 
than  in  our  country.  This  was  perhaps  due  in  a  large 
measure  to  the  fact  that  the  examiners  are  paid  on 
a  different  basis  from  those  who  acted  under  the  Na- 
tional Banking  Act.  Under  the  latter  system  the 
examiners  were  paid  so  much  for  each  bank  examined. 
Hence  it  was  to  their  advantage  to  examine  as  many 
institutions  as  possible,  and  this  tended  to  lax  methods. 
In  Canada  the  examiners  receive  a  stated  salary  no 
matter  how  many  banks  they  examine.  A  typical 
example  of  the  difference  in  examinations  may  be 
mentioned.  An  American  banker  who  had  the  oppor- 
tunity of  watching  an  examination  conducted  into  the 
affairs  of  a  branch  of  a  Canadian  bank  in  the  United 
States,  was  amazed  at  the  thoroughness  with  which 
every  roll  of  coins  was  examined.  In  his  own  bank 
he  had  found  it  customary  for  the  bank  examiner  to 
take  the  figure  on  the  roll  as  representing  the  contents. 
The  Canadian  examiner  opened  every  roll  and  counted 
every  coin. 

The  Canadian  banks  are  not  unrelated  to  each  other. 
The  banks  have  formed  an  association  which  acts  in 
a  certain  degree  as  the  Treasury  does  for  the  National 
banks.  The  important  function  of  this  association 
is  the  clearing  of  the  various  issues  of  bank  notes. 
The  Canadian  banks  are  not  restricted  in  regard 
to  the  amount  of  notes  which  they  may  issue,  and 
there  are  no  bonds  to  be  deposited  as  security.  The 
notes  themselves  form  a  first  lien  upon  the  assets  of 


THE  FEDERAL  RESERVE  SYSTEM  245 

the  bank.  Every  bank,  however,  is  compelled  to 
maintain  a  fund  for  the  redemption  of  its  notes.  This 
fund,  which  amounts  to  five  per  cent  of  the  circulation, 
is  placed  in  the  hands  of  the  Minister  of  Finance. 
The  association  clears  the  notes  which  come  up  for 
redemption,  and  the  ownership  in  the  fund  varies 
according  to  the  amount  which  is  presented  for  redemp- 
tion. 

In  the  case  of  the  failure  of  a  bank,  its  outstanding 
notes  commence  to  bear  interest  at  the  rate  of  six 
per  cent  at  once.  Hence  they  are  eagerly  sought  as 
an  investment,  and  in  a  very  short  time  pass  out 
of  circulation.  The  notes  are  redeemed  from  the 
central  fund,  no  matter  how  small  the  amount  owned 
by  the  defunct  bank.  The  assets  of  the  bank  when 
realized  must  make  good  the  amount  paid  out  of  the 
fund  in  excess  of  the  five  per  cent  placed  originally 
by  the  bank. 

The  fact  that  each  of  the  banks  may  possibly  be 
called  upon  to  supply  a  deficit  in  case  the  assets  of 
the  bankrupt  institution  are  not  sufficient  to  pay 
for  the  outstanding  notes,  gives  each  bank  an  interest 
in  seeing  that  no  institution  over-issues  its  notes. 

The  actual  control  of  the  banks  is  left  very  largely 
in  the  hands  of  the  bankers  themselves,  but  experi- 
ence has  proved  that  in  this  case,  at  least,  the  bankers 
have  justified  the  confidence  placed  in  them  by  the 
government. 

The  difficulties  which  the  National  banks  experienced 
in  regard  to  the  lack  of  an  efficient  rediscount  system 
have  not  arisen  in  Canada,  because  of  the  branch 
system.  The  parent  bank  naturally  acts  as  the  re- 


246  AN    INTRODUCTION   TO   ECONOMICS 

discounting  bank,  but  with  the  advantage  that  there 
is  no  rediscount  rate.  Any  branch  bank  which  requires 
additional  funds  has  merely  to  call  upon  its  head 
office,  which  may  withdraw  funds  unused  by  other 
branches. 


CHAPTER  XIX 

THE  NATURE  AND   MECHANISM   OF  TRADE 

The  Nature  of  Trade  —  It  has  been  made  abun- 
dantly clear  in  previous  chapters  that  trade  consists 
essentially  in  the  exchange  of  goods  and  services  for 
goods  and  services.  It  is  necessary,  however,  to 
examine  this  proposition  a  little  more  closely  than 
we  have  been  able  to  up  to  the  present.  There  are 
considerable  difficulties  involved  in  realizing  that 
money  is  merely  an  intermediary  and  not  a  prime 
necessity.  When  a  tailor  makes  a  suit  of  clothes  he 
expects  to  receive  money  in  exchange  for  it.  When 
the  grocer  renders  his  monthly  bill,  he  expects  to  be 
paid  in  some  form  or  other  of  money.  When  the 
workman  has  finished  his  weekly  work  he  demands 
money  in  payment  for  that  work.  Money  is,  of 
necessity,  so  closely  associated  with  the  reward  for 
labor,  or  the  quid  pro  quo  in  an  exchange,  that  it 
inevitably  tends  to  be  regarded  as  a  good  in  itself. 
It  is,  of  course,  true  that  standard  money  is  a  good 
in  itself  in  that  it  possesses  a  value  as  a  commodity, 
apart  from  its  value  as  a  means  of  facilitating  exchange. 
But  the  greater  part  of  the  money  instruments  in 
use  to-day  have  no  intrinsic  commodity  value. 

It  is  so  very  difficult  to  realize  in  practice  that  a  suit 
of  clothes  is  worth,  let  us  say,  a  week's  work,  or  a  six- 
hundred-mile  railroad  journey,  that  it  is  almost  always 
247 


248  AN    INTRODUCTION   TO   ECONOMICS 

'preferable  to  speak  of  it  as  being  worth  so  many  dollars. 
But  when  we  say  so  many  dollars  we  are  obscuring 
the  facts  and  not  simplifying  them.  The  appar- 
ently more  difficult  form  of  expression  in  terms  of  a 
week's  work,  or  a  journey  by  rail,  is  really  more 
accurate. 

When  Tom  Smith  gives  a  week's  work  in  return  for 
$25,  he  is  really  working  for  so  much  food,  shelter, 
clothing,  amusement,  education,  and  so  on.  He  can- 
not, of  course,  give  part  of  his  work  to  the  clothier, 
another  part  to  the  house-builder,  a  third  to  the  grocer, 
and  so  on.  Or,  at  least,  it  is  not  readily  apparent 
how  he  can  do  so.  In  reality  he  must  give  those  who 
build  his  house  and  provide  his  food  and  clothing  the 
results  of  his  work.  The  function  of  trade  is  to  facili- 
tate this  process. 

We  have  already  seen  that  each  produces  more  of 
a  certain  requirement  than  is  necessary  for  his  own 
consumption.  Indeed  it  is  quite  possible  that  many 
will  spend  their  whole  time  in  producing  some  commod- 
ity for  which  they  have  personally  no  need.  Examples 
of  this  are  easy  to  suggest  — -  a  teetotaler  working  in 
a  brewery,  a  surgical-instrument  maker  who  is  not 
a  surgeon,  an  optician  whose  own  eyes  are  perfect. 
Nevertheless,  each  is  engaged  in  producing  something 
which  is  desired  by  somebody.  Trade  arises  in  the 
necessity  that  each  should  get  as  much  as  possible 
of  what  he  desires,  and  should  concentrate  his  energies 
on  the  production  of  some  one  article  which  is  desired 
by  others. 

The  more  easily  the  necessary  exchanges  are  effected, 
the  greater  is  the  likelihood  that  all  will  be  satisfied, 


THE  NATURE  AND  MECHANISM   OF  TRADE     249 

or  that  all  can  be  satisfied.  The  student  must  remem- 
ber, of  course,  that  we  are  not  dealing  with  the  relative 
amounts  of  goods  and  services  received  by  each  mem- 
ber of  the  community.  That  is  a  totally  different 
problem.  At  present  we  are  simply  concerned  with 
the  mechanism  of  the  process,  not  with  the  ethics 
of  the  distribution.  We  shall  consider  the  question 
of  the  distribution,  or  allocation  of  the  products  of 
industry,  in  a  future  section  of  the  book. 

The  Mechanism  of  Exchange  —  To  turn,  then,  to 
the  question  of  this  mechanism  of  exchange  :  we  have 
to  consider  the  fundamental  provision  of  a  means  of 
offsetting  the  products  of  one  man's  labor  against 
those  of  another  man.  At  the  present  time,  although 
we  constantly  speak  as  if  every  obligation  of  a  com- 
mercial nature  was  solved  by  the  use  of  money,  as 
a  matter  of  fact  money  comparatively  seldom  enters 
into  the  matter  at  all.  A  complex  system  of  book- 
keeping transactions  takes  its  place.  We  have  not 
space  to  analyze  this  system  carefully,  but  we  may 
obtain  a  sound  idea  of  the  nature  of  its  work  by  con- 
sidering the  processes  through  which  most  common 
business  transactions  pass. 

We  shall  assume,  at  the  outset,  that  the  banks  may 
be  regarded  as  a  single  institution.  The  reasonable- 
ness of  this  assumption  is  obvious  from  the  study  of 
the  chapters  on  banking.  Now  let  us  suppose  that 
the  Electric  Hardware  Company  desires  to  purchase 
a  supply  of  copper  wire,  nickel,  steel,  rubber,  and 
silk  for  the  purpose  of  carrying  out  its  manufacturing 
program.  These  goods  must  be  paid  for.  If  "  cash  " 
is  demanded,  the  Electric  Hardware  Company  forwards 


250  AN  INTRODUCTION   TO   ECONOMICS 

its  check  to  each  of  the  various  dealers  as  payment. 
These  checks  are  in  turn  deposited  by  the  copper, 
nickel,  steel,  and  silk  dealers  with  the  banking  system 
where,  for  the  present,  we  shall  leave  them. 

The  Trade  Acceptance  —  Meanwhile  the  hardware 
company  proceeds  with  its  manufacture  and  turns 
out  electric  irons,  toasters,  heaters,  percolators,  and 
so  on,  as  required  in  the  market,  or,  at  least,  as  the 
company  thinks  they  are  required.  Its  salesmen  trav- 
eling throughout  the  country  dispose  of  the  products 
to  the  local  dealers,  giving,  let  us  say,  sixty  days'  credit. 
The  Electric  Hardware  Company,  however,  must  have 
"  cash  "  with  which  to  pay  its  workmen.  It  is  quite 
possible  that  its  balance  at  the  bank  is  nearly  ex- 
hausted by  the  checks  drawn  in  payment  of  the 
copper  and  nickel  bills.  In  order  to  obtain  the  re- 
quired funds  it  is  necessary  to  anticipate  the  pay- 
ment of  the  goods  sold  to  the  retail  dealers.  There  are 
many  different  ways  in  which  this  anticipating  may 
be  done,  and  it  is  impossible  to  outline  all.  Let  us  take 
the  method  which  will,  in  all  probability,  be  the  one 
adopted  in  ninety-nine  cases  out  of  a  hundred  within 
the  next  few  years  —  the  method  of  the  "  Trade  Ac- 
ceptance." At  the  time  the  Electric  Hardware  Com- 
pany dispatches  the  goods  to  the  retailer,  let  us  say  to 
the  Jones ville  Hardware  Store  (W.  Thomson,  proprie- 
tor), it  makes  out  a  draft  somewhat  as  follows : 


THE  NATURE  AND  MECHANISM  OF  TRADE  251 

$500.00  DAYTON,  OHIO,  January  10,  1919. 

To    THE  JONESVILLE  HARDWARE  STORE, 
WAI.  THOMSON,  Proprietor, 

Jonesville. 

Pay  to  the  order  of  the  First  National  Bank,  Dayton, 
Ohio,  the  sum  of  Five  Hundred  Dollars  sixty  days  after  the 
date  hereof. 

This  acceptance  arises  out  of  the  sale  and  purchase  of 
Electrical  Goods  invoiced  January  10,  1919,  for  the  sum  of 
$500  and  sold  to  the  Jonesville  Hardware  Store. 

THE  ELECTRIC  HARDWARE  COMPANY, 

Per  J.  SMITH,  President. 

In  this  particular  illustration  we  will  assume  that 
the  goods  have  been  sold  on  the  basis  of  accepting  the 
draft  immediately  upon  receipt  of  the  goods.  This 
is  not  by  any  means  always  the  case,  but  the  methods 
are  so  numerous  that  we  may  as  well  take  one  as 
another,  especially  as  the  particular  method  does  not 
affect  the  principle.  The  draft  is  sent,  with  the 
invoice  of  the  goods,  to  Thomson  of  Jonesville,  who 
writes  across  the  face  of  the  draft  the  words  "  Accepted, 
payable  at  the  Merchants'  Bank,  Jonesville,"  and 
signs  his  name.  The  document  is  now  known  as  an 
"  acceptance  "  and  is  returned  to  the  Electric  Hard- 
ware Company.  The  latter  company  now  takes  the 
acceptance  to  its  bank  and  discounts  it,  obtaining 
the  discount  in  the  form  of  an  increase  in  its  de- 
posit credit.  The  hardware  company  can  now  draw 
checks  against  this  new  deposit  credit  with  which  to 
pay  such  current  expenses  as  light,  heat,  insurance, 
wages,  and  so  forth.  Meanwhile  the  Jonesville  Store 
is  busy  selling  the  goods.  Most  of  the  customers 


252  AN  INTRODUCTION   TO   ECONOMICS 

will  pay  in  notes;  some  by  check;  a  few,  possibly, 
in  cash  (according  to  the  price  of  the  different  articles). 
Thomson  deposits  the  funds  thus  obtained  in  his  bank 
in  order  to  meet  the  acceptance  when  the  sixty  days 
are  up. 

At  the  end  of  the  sixty  days,  the  First  National 
Bank  of  Dayton  forwards  the  acceptance  to  its  agent 
in  Jonesville,  who  presents  it  for  payment  to  the  Mer- 
chants' Bank.  The  latter  informs  Thomson  that  his 
acceptance  has  been  presented  for  payment  and 
requests  instructions,  in  case  it  has  not  already  received 
these  instructions.  Thomson  then  tells  the  bank  to 
pay  the  acceptance  and  to  charge  his  account.  The 
Merchants'  Bank  pays  the  agent  of  the  First  National 
of  Dayton  (perhaps  it  is  itself  the  agent),  who  in  turn 
credits  the  First  National  with  the  amount. 

The  whole  transaction  is  now  complete,  and  the 
student  can  readily  see  that  little  or  no  cash  has  been 
involved.  What  has  actually  happened,  however, 
is  that  certain  copper  miners,  steel  workers,  and  so 
on,  have  been  enabled  to  obtain  food  and  clothing ; 
the  product  of  their  labor  has  resulted  in  the  provision 
of  raw  material  for  other  workmen  who,  in  turn,  have 
received  the  equivalent  of  food,  clothing,  and  so  on. 
Their  work  has  passed  into  the  hands  of  a  retail  dealer, 
who,  in  return  for  the  means  of  purchasing  his  own 
food  and  other  requirements,  has  passed  the  goods 
into  the  hands  of  the  ultimate  consumers.  In  this 
manner  the  whole  transaction,  or  series  of  transactions, 
is  completed..  The  part  played  by  the  banking  system 
is  important.  Without  the  interposition  of  the  banks, 
there  would  be  hardly  any  possibility  of  financing 


THE  NATURE  AND  MECHANISM   OF  TRADE      253 

the  different  stages  of  the  process  of  exchanging  the 
products  of  the  miner  and  the  smelter  for  those  of 
the  grocer  and  butcher.  And  yet  the  banks  them- 
selves produce  no  commodity ;  they  merely  facilitate 
the  exchanging  of  commodities.  They  act,  it  may 
be  said,  as  the  limestone  which  is  used  in  smelting 
iron.  The  iron  ore  could  be  smelted  at  a  very  high 
temperature  without  the  use  of  the  limestone  "  flux,  " 
but  by  using  the  limestone,  which  is  not  altered  in, 
the  process,  the  ore  is  melted  at  a  much  lower  tempera- 
ture. The  banks  act  as  the  flux  of  trade. 


CHAPTER  XX 

INTERNATIONAL  TRADE 

Meaning  of  the  Word  International  —  In  the  last 
.chapter  we  considered  the  question  of  the  process  of 
trade  between  individuals,  and  we  saw  that  in  this 
trade  the  essential  process  is  the  exchange  of  goods 
and  services  for  goods  and  services,  or,  in  other  words, 
the  exchange  of  utilities.  Is  there  any  essential  differ- 
ence between  the  processes  of  trade  between  individ- 
uals and  between  nations  ?  It  is  fair  to  say  that  there 
are  no  fundamental  differences,  but  in  spite  of  this 
there  are  sufficient  modifying  influences  to  make  it 
worth  while  to  give  special  and  separate  attention  to 
the  question  of  international  trade. 

Definition  of  Nation  —  Our  first  difficulty  is  to  define 
exactly  what  is  meant  by  a  nation.  Are  we,  for  in- 
stance, to  regard  each  state  of  the  Union  as  a  sepa- 
rate nation  or  merely  as  one  part  of  the  nation? 
Do  Canada,  South  Africa,  and  Australia  form  separate 
nations  or  are  they  part  of  the  British  nation?  To 
answer  these  questions  properly  it  is  necessary  to  dis- 
tinguish between  the  political  point  of  view  and  the 
economic.  A  nation,  in  the  political  sense  of  the  term, 
is  a  group  of  individuals  who  have  been  and  are  asso- 
ciated with  one  another,  who  are  conscious  of  a  unity 
secured  by  the  ties  of  a  common  language,  common 
history,  common  religion,  or  common  government,  or 
254 


INTERNATIONAL  TRADE  255 

by  a  combination  of  two  or  more  of  these.  From  the 
political  point  of  view,  therefore,  the  British  colonies 
form  part  of  the  British  nation,  and  the  States  of  the 
Union  are  part  of  the  American  nation. 

The  ties  which  bind  together  the  members  of  the 
political  nation  are,  however,  not  the  same  as  those 
which  bind  the  members  of  the  economic  nation. 
Geographical  considerations  play  a  much  more  impor- 
tant part.  In  the  case  of  domestic  trade,  as  we  have 
already  seen,  there  is  a  comparative  freedom  of  motion 
for  labor  and  capital  which  tends,  on  the  whole,  to 
keep  those  factors  of  production  fluid.  Capital, 
however,  is  always  somewhat  more  fluid  than  labor. 
The  wider  the  market  the  less  apparent  is  the  fluidity. 
But  this  applies  much  more  to  labor  than  to  capital. 
Ties  of  home  and  kindred  hold  the  workman  in  one 
place,  or  within  a  comparatively  short  radius  of  one 
place,  when  economic  motives  tend  to  make  him  move. 
The  essential  factor,  then,  which  distinguishes  one 
economic  nation  from  another  is  a  comparative  im- 
mobility of  labor  and  capital.  The  distinction  is  often 
enforced  by  more  artificial  bars  to  exchange,  as  in 
the  case  of  prohibitions  and  customs  duties,  as  well 
as  by  the  mechanical  difficulties  caused  by  different 
coinage  and  currency  systems. 

From  this  point  of  view,  while  we  should  still  regard 
the  states  of  the  Union  as  forming  part  of  the  same 
nation,  economically  it  is  better  to  assume  that  the 
colonies  of  Great  Britain  are  separate  nations.  Their 
distance  from  the  home  country  and  from  each  other 
renders  labor  comparatively  immobile,  and,  to  a 
less  extent,  capital  also.  Their  currency  systems  are 


256  AN    INTRODUCTION   TO   ECONOMICS 

not  always  the  same  as  that  of  the  mother  country 
and  the  artificial  hindrances  of  protective  duties  tend 
also  to  distinguish  the  nations. 

Essentials  of  International  Trade  —  It  is  important 
to  recognize  that  the  fundamentals  of  international 
trade  do  not  differ  from  those  of  domestic  trade. 
Utilities  are  still  exchanged  for  utilities.  International 
trade  is  not  merely  the  bartering  of  goods  for  goods. 
We  use  the  word  barter  advisedly,  although  foreign 
trade  is  carried  on  under  a  system  of  credit  and  money 
economy.  The  function  of  the  money  and  credit 
system,  however,  is,  as  we  have  seen,  merely  to  lubri- 
cate the  process  of  exchange,  and  the  lubricant  does 
not  alter  the  real  nature  of  the  process. 

Law  of  Comparative  Cost  —  Exchange  of  any  kind 
only  results  when  two  parties  are  unsatisfied  with 
their  present  possessions  and  are  unable  to  supply 
their  own  additional  requirements  cheaply  enough 
themselves.  If  each  individual  by  his  own  unaided 
efforts  were  able  to  satisfy  all  his  wants,  there  would 
be  no  trade  at  all.  But  we  have  seen  that  even  if 
each  individual  does  provide  all  his  own  necessities, 
the  method  is  wasteful,  for  it  does  not  take  advantage 
of  the  economies  of  division  of  labor.  A  successful 
lawyer  may  be  able  to  type  his  own  briefs  and  letters. 
He  does  not  do  so,  however,  because  he  can  employ 
his  time  more  profitably  in  other  ways.  The  same 
is  true  of  a  nation.  It  is  possible  for  England,  for 
instance,  to  rear  silkworms  and  so  to  produce  its  own 
raw  material  for  silk.  It  is  also  possible  for  France 
to  produce  cotton  and  woolen  goods.  But  in  each 
case  the  capital  and  labor  employed  would  not  earn 


INTERNATIONAL  TRADE  257 

so  much  as  by  being  applied  in  England,  say,  to  the 
production  of  cottons  and  woolens,  and  in  France 
to  the  production  of  silk,  the  surplus  products  in  each 
case  being  exchanged. 

In  order  to  make  this  clear,  let  us  suppose  that 
there  are  only  two  countries,  A  and  B,  engaged  in 
trade,  and  that  they  actually  only  produce  two  commod- 
ities, wool  and  silk.  And  let  us  further  suppose  that 
in  A  the  application  of  a  given  amount  of  labor  and 
capital  (which  we  may  call  a  unit  of  production)  will 
produce  ten  yards  of  woolen  cloth  and  a  similar  unit 
of  production  will  produce  five  yards  of  silk.  In  B 
a  unit  of  production  will  produce  ten  yards  of  wo'ol  and 
fifteen  yards  of  silk. 

Now  if  each  of  the  two  countries  produces  both 
wool  and  silk,  there  will  be  a  total  production  of  20 
yards  of  woolen  cloth  and  20  yards  of  silk.  It  is 
obvious,  however,  that  a  better  total  result  will  be 
obtained  if  A  specializes  in  woolen  cloth  and  B  in 
silk.  In  that  case  the  total  production  will  be  20 
yards  of  woolen  cloth  and  30  yards  of  silk.  There 
would  thus  be  a  profit  for  the  communities  of  both 
countries  of  10  yards  of  silk. 

Taking  into  consideration,  therefore,  the  purely 
economic  reasons,  there  is  a  considerable  profit  in 
this  "  territorial  division  of  labor  "  as  international 
trade  has  well  been  called.  The  very  existence  of 
international  trade  shows  that  this  profit  is  realized. 

Benefits  of  International  Trade  —  It  is  obvious 
from  the  above  brief  account  of  the  influence  of  com- 
parative cost  upon  production  that  there  is  a  definite 
increase  in  total  product  when  the  separate  nations 


258  AN  INTRODUCTION   TO   ECONOMICS 

specialize  in  the  products  for  which  they  are  most 
suited.  This  definite  increase  would  be  utterly  im- 
possible without  the  development  of  international 
trade.  Just  in  the  same  way,  the  increase  in  product 
due  to  specialization  in  labor  gave  rise  to  domestic 
trade. 

The  great  benefits  to  be  derived  from  international 
trade,  therefore,  are  due  to  the  extension  of  the  prin- 
ciple of  division  of  labor  to  the  territorial  division  of 
labor,  which  is  the  essence  of  international  trade. 
It  means  an  increased  economy  in  the  use  of  labor 
and  capital.  The  problem  which  is  set  to  humanity 
is  to  make  the  most  of  the  natural  resources  of  the 
world.  Anything  which  tends  to  increase  the  total 
returns  from  the  application  of  the  agents  of  produc- 
tion to  the  natural  resources  of  the  earth,  to  that 
extent  benefits  humanity. 

It  must  not  be  thought  that  this  is  merely  a  theo- 
retical discussion  without  basis  in  actual  fact.  The 
truth  of  the  theory  can  be  illustrated  from  the  cir- 
cumstances of  any  country  which  does  any  foreign 
trade  at  all.  We  have  only  eliminated  certain  com- 
plications due  to  the  fact  that  international  trade  is 
seldom,  if  ever,  between  two  countries  only.  The 
trading  is  triangular  or  even  more  complicated  still. 
Let  us  take  the  case  of  the  foreign  trade  of  the  United 
States.  The  materials  which  constitute  the  content 
of  the  foreign  trade  of  this  country  may  be  divided 
into  raw  materials,  or  crude  products,  foodstuffs, 
and  manufactured  products.  In  1914  (i.e.,  before 
the  outbreak  of  the  war)  the  exports  of  the  United 
States  were  very  largely  divided  between  Europe  and 


INTERNATIONAL  TRADE  259 

North  America,  sixty-three  per  cent  going  to  Europe 
and  twenty-two  per  cent  to  North  America.  The 
imports  came  from  Europe,  North  and  South  America, 
and  Asia,  the  rough  proportions  being  forty-seven 
per  cent  from  Europe,  twenty-two  per  cent  from  North 
America,  eleven  per  cent  from  South  America,  and 
fifteen  per  cent  from  Asia. 

Our  exports  to  Europe  consisted  largely  of  raw 
materials  and  foodstuffs  and  our  imports  from  that 
quarter,  of  manufactured  goods.  We  imported  from 
the  other  countries  raw  materials  and  exported  manu- 
factures. Now  it  is  quite  possible,  for  instance,  for 
Great  Britain  to  feed  all  her  own  population,  as  far 
as  cereal  foodstuffs  are  concerned,  from  her  own  agri- 
cultural area.  It  has  been  calculated  that,  with 
modern  methods  of  intensive  agriculture,  Great  Britain 
could  feed  a  population  of  eighty  millions,  or  nearly 
twice  her  present  population.  Britain  does  not  do 
so,  however,  for  she  finds  it  better  and  more  profitable 
to  devote  her  attention  very  largely  to  manufacture, 
and  to  rely  upon  the  United  States,  Canada,  Australia, 
and  Russia  for  her  wheat.  The  other  countries  find 
it  better  to  devote  their  energies  and  facilities  to  the 
production  of  these  foodstuffs  and  to  rely  upon  Great 
Britain,  or  upon  the  United  States  for  manufactures. 
It  will  be  obvious  to  the  student  now  that  our  original 
hypothesis  covers  the  actual  facts. 

The  war  has  produced  a  very  natural  effect  upon 
the  exports  of  this  country.  Much  of  the  capital 
of  Europe  has  been  diverted  from  its  ordinary  com- 
mercial and  industrial  channels  into  the  manufacture 
of  war  materials,  and  this  has  thrown  the  burden  of 


260  AN   INTRODUCTION   TQ   ECONOMICS 

manufacture  upon  this  country.  Even  in  the  manu- 
facture of  war  materials  the  resources  of  the  warring 
countries  were  not  sufficient  in  themselves  to  supply 
the  immense  quantity  of  arms  and  ammunition  re- 
quired, and  hence  the  United  States  has  also  made 
large  exports  of  these  commodities.  About  half 
the  increase  in  our  exports  of  the  last  year  (1918) 
consisted  of  war  materials  and  the  other  half  com- 
prised manufactured  articles  which  the  European 
countries  would  otherwise  have  made  for  themselves. 

It  is  true,  of  course,  that  a  considerable  proportion 
of  this  increase  in  exports  is  temporary,  as  it  is  due 
simply  to  war  conditions.  But  there  is  a  strong 
probability  that  much  of  it  will  remain,  owing  in  a 
large  measure  to  the  increased  facilities  for  production 
which  the  forced  activities  of  the  past  few  years  have 
produced. 

Theory  of  International  Value  —  We  must  now  con- 
sider the  question  of  the  division  of  the  benefits  result- 
ing from  the  territorial  division  of  labor.  In  all  ex- 
change there  is  a  certain  mutual  advantage,  as  we  have 
seen  in  a  previous  chapter.  Exchange  will  not  take 
place  unless  each  of  the  parties  conceives  that  he  is 
being  benefited.  Apart,  however,  from  this  inevitable 
mutual  advantage,  we  must  consider  the  actual  pro- 
portionate division  of  the  increased  product. 

Let  us  recur  to  our  original  hypothesis.  In  the 
two  countries,  A  and  B,  we  found  that,  if  the  law  of 
comparative  cost  is  actually  carried  out,  there  will 
be  a  total  increase  of  product  amounting  to  10  yards 
of  silk  for  every  4  units  of  production.  How  is 
that  10  yards  to  be  divided?  Will  it  go  entirely  to 


INTERNATIONAL  TRADE  261 

A  which  produces  no  silk  at  all,  or  will  only  the  amount 
(five  yards)  which  A  could  have  produced  itself  be 
exchanged  for  the  10  yards  of  woolens  which  A  has 
actually  produced  in  addition  to  its  own  requirements  ? 

There  are  many  considerations  to  be  noted  before 
a  definite  conclusion  can  be  arrived  at.  In  the  bar- 
gaining between  two  individuals  much  depends  upon 
the  comparative  knowledge  and  skill  displayed  by 
two  in  determining  the  rate  of  exchange.  In  any 
individual  case  it  is  almost  impossible  to  forecast 
what  the  rate  will  be.  In  taking  the  case  of  trade 
between  communities,  however,  the  matter  is  some- 
what easier,  for  the  individual  variations  in  knowledge 
and  ability  are  canceled  according  to  the  law  of 
averages.  In  any  case,  however,  there  are  certain 
limits.  In  our  particular  illustration,  we  have  in  A 
a  surplus  of  10  yards  of  wool  and  in  B  a  surplus  of 
15  yards  of  silk.  A  will  certainly  not  accept  less  than 
5  yards  of  silk  for  its  10  yards  of  wool,  for  it  would 
prefer  to  apply  the  labor  which  produced  the  wool 
to  the  making  of  silk  and  thus  obtain  the  5  yards. 
On  the  other  hand,  B  will  not  give  more  than  15  yards 
of  silk  for  10  yards  of  woolens,  for  it  could  produce 
the  10  yards  of  woolens  by  applying  the  unit  of  pro- 
duction which  produced  the  silk,  to  the  making  of 
woolens.  Hence  the  exchange  will  not  be  less  than 
5,  nor  more  than  15  yards  of  silk  for  10  yards  of 
woolens. 

These,  however,  are  merely  the  outside  limits.  It 
may  happen  that  A  does  not  require  more  than  10 
yards  of  wool,  nor  more  than  15  yards  of  silk, 
and  B's  requirements  are  similar.  In  that  case,  the 


262  AN  INTRODUCTION  TO   ECONOMICS 

exchange  will  be  at  the  rate  of  10  yards  of  woolens 
for  15  yards  of  silk. 

So  simple  an  exchange,  however,  uncomplicated 
by  questions  of  cost  of  transport  and  hindrances  of 
duties,  is  seldom  secured.  Essentially  the  exchange 
will  be  decided  by  the  reciprocal  demands  of  the  two 
countries.  That  is  to  say,  the  law  of  supply  and 
demand  will  regulate  the  rate  of  exchange.  The 
student  must  remember,  in  this  discussion,  what 
was  said  in  Chapter  X  in  regard  to  the  limitation  of 
the  law  of  supply  and  demand. 

The  question  is  further  complicated  when  we  con- 
sider the  exchange  as  being  between  three  or  more 
countries  instead  of  between  two  only,  and  also  when 
we  add  the  cost  of  transportation  and  the  effects  of 
protective  duties.  To  give  a  full  discussion  of  inter- 
national trade  treating  carefully  the  questions  involved 
in  the  additional  difficulties  suggested,  would  be  beyond 
the  scope  of  this  book.  One  point,  however,  is  worth 
considering,  in  that  it  appears  to  refute  the  theory 
as  outlined  in  the  foregoing  paragraphs.  According 
to  this  theory  there  would  be  no  point  in  importing 
into  and  exporting  from  a  country  the  same  goods, 
and  yet  a  glance  at  the  tables  of  imports  and  exports 
of  many  countries  will  show  that  this  appears  to  be 
the  actual  fact. 

As  a  matter  of  fact,  however,  the  export  and  import 
of  the  same  commodity  is  an  appearance  rather  than 
a  reality.  The  United  States  both  imports  and 
exports  pig  iron.  To  the  layman,  pig  iron  is  simply 
pig  iron.  But  to  the  expert  it  is  a  generic  name  for 
many  different  substances.  The  varieties  imported 


INTERNATIONAL  TRADE  263 

into  this  country  usually  have  some  special  qualities 
which  the  home-produced  iron  lacks.  This  is  the  case 
in  regard  to  the  import  of  spiegel  iron  and  ferro- 
manganese.  In  the  case  of  the  import  and  export 
of  cotton  goods,  again,  the  goods  are  of  different  grades 
and  qualities  from  those  manufactured  in  this  country 
and  exported  therefrom,  and,  consequently,  they  are 
actually  different  commodities. 

International  Price  —  We  have  so  far  argued  as 
if  the  whole  of  international  trade  were  carried  on 
under  a  system  of  barter.  In  a  sense,  of  course,  that 
is  true,  but  only  in  the  sense  that  all  exchange  is 
merely  the  exchange  of  goods  and  services  for  goods 
and  services,  the  process  being,  as  it  were,  lubricated 
by  the  money  and  banking  system.  Our  argument, 
therefore,  is  not  vitiated  by  the  fact  that  money  and 
credit  instruments  are  used  to  a  very  high  degree  in 
the  process  of  international  exchange.  We  shall  have 
occasion  in  the  next  chapter  to  discuss  the  method  of 
international  exchange,  and  at  present  the  discussion 
must  be  confined  to  the  question  of  the  comparative 
prices  of  products  in  the  producing  country  and  in 
the  importing  country. 

Again  it  is  necessary,  for  the  sake  of  simplifying  the 
argument,  to  ignore  at  first  the  effect  of  cost  of  trans- 
portation and  of  artificial  interferences  to  the  process 
of  exchange.  Leaving  these  two  considerations  out 
of  account  for  the  present,  therefore,  and  following 
the  working  of  the  laws  of  supply  and  demand  in  a 
free  market,  we  arrive  naturally  at  the  conclusion, 
that  there  will  be  an  equation  of  prices.  The  export 
of  the  goods  merely  makes  the  market  wider  and  the 


264  AN  INTRODUCTION   TO   ECONOMICS 

full  and  free  play  of  competition  will  result,  as  in  the 
former  market,  in  the  establishment  of  a  market  price. 
It  must  always  -be  remembered,  however,  that  the 
working  of  the  law  of  supply  and  demand  is  limited 
in  the  manner  explained  in  Chapter  X. 

Price  is,  of  course,  merely  the  statement  of  value 
in  terms  of  money.  Consequently  there  must  be  an 
equation  of  the  value  of  money  in  the  exporting  and 
importing  countries  in  order  that  our  statement 
of  the  equation  of  prices  may  hold  good.  Such  an 
equation  follows,  however,  from  the  facts  that  we 
have  presupposed,  i.e.,  a  free  and  open  market.  In 
the  case  of  countries  in  which  the  same  commodity 
is  used  as  money,  as,  for  instance,  where  both  countries 
use  the  gold  standard,  any  increase  in  the  value  of 
gold  in  one  country  unaccompanied  by  a  similar  increase 
in  the  other  will  cause  a  stream  of  gold  to  flow  towards 
the  country  where  its  value  is  higher  and  thus,  by 
increasing  the  supply,  cause  a  fall  to  the  same  value 
as  that  in  the  country  from  whence  the  gold  was 
exported. 

The  Cost  of  Transport  —  An  essential  variation  in 
the  prices  of  the  two  countries  is  due  to  the  cost  of 
transportation.  But  this  increase  in  the  cost  due  to 
the  expense  of  transporting  the  goods  from  one  country 
to  another  may  be  regarded  as  a  payment  for  an 
additional  service,  the  services  of  transport.  From 
the  price  in  the  importing  country,  therefore,  we  may 
deduct  that  part  which  is  due  to  freight  charges,  as 
being  payment  for  the  service  of  transportation  — 
an  additional  utility  to  that  possessed  by  the  goods 
imported.  Hence  in  a  theoretical  discussion,  such 


INTERNATIONAL  TRADE  265 

as  the  present,  the  truth  of  the  argument  is  not  im- 
paired by  any  question  of  increased  price  due  to  freight 
charges. 

The   question   of  the  influence   of  tariffs   must  be 
deferred  until  a  later  chapter. 

The  Equation  of  Indebtedness  —  It  will  be  noticed 
that  care  has  been  taken  to  speak  of  the  exchange  of 
goods  and  services,  rather  than  of  goods  alone.  It  is 
frequently,  but  erroneously  thought  that  international 
trade  consists  merely  in  the  export  and  import  of 
actual  physical  materials.  This  idea  has  given  rise 
to  the  theory  that  is  known  as  the  "  balance  of  trade." 
This  theory  has  played  a  very  important  part  in  the 
past  history  of  economics  and  indeed  is  still  frequently 
used  in  commercial  articles.  It  has  always  been 
realized  that  international  trade,  like  all  other  trade, 
results  in  an  equation  of  satisfactions,  that  is,  each 
party  to  the  transaction  conceives  himself  as  getting 
as  good  as  he  gave.  Now  it  is  obvious  that  in  inter- 
national trade  the  amount  of  actual  commodity 
exports  seldom  equals  the  amount  of  actual  commodity 
imports.  How,  then,  is  the  difference  made  up  ? 
,  It  was  assumed  that  the  difference,  or  balance, 
was  made  up  by  the  import  or  export  of  bullion  to 
the  amount  necessary  to  restore  the  balance.  If  a 
country  exported  a  hundred  million  dollars'  worth  of 
goods  and  imported  a  hundred  and  twenty  million 
dollars'  worth,  it  was  assumed  that  twenty  million 
dollars  had  to  be  exported  in  bullion  or  coin  to  restore 
the  balance.  When  the  theory  was  formulated,  there 
was  an  erroneous  idea  that  a  country's  wealth  could 
be  measured  by  the  amount  of  gold  within  that  country. 


266  AN    INTRODUCTION   TO   ECONOMICS 

Hence  anything  which  tended  to  draw  gold  to  the 
country  was  regarded  as  being  beneficial  and  anything 
which  tended  to  drive  gold  away  was  harmful.  In 
case  imports  exceeded  exports,  therefore,  the  country 
was  assumed  to  be  in  a  bad  position,  for  gold  must 
go  out  of  the  country  to  make  up  the  difference.  In 
this  case,  the  country  was  said  to  have  "  an  adverse 
balance  of  trade."  If,  on  the  other  hand,  exports 
exceeded  imports,  the  balance  was  favorable,  for  then 
gold  would  flow  into  the  country. 

A  study  of  the  imports  and  exports  of  bullion,  how- 
ever, will  show  that  they  bear  little  relation  to  the 
exports  and  imports  of  other  commodities.  The 
theory,  therefore,  fails,  for  it  does  not  fit  the  facts. 
As  a  matter  of  fact,  gold  is  simply  a  commodity  like 
any  other,  and  obeys  the  same  laws.  As  far,  then,  as 
the' welfare  of  the  country  is  concerned,  the  balance  of 
trade  is  of  little  importance.  It  must  not  be  thought, 
of  course,  that  the  balance  of  trade  is  without  signifi- 
cance. There  is,  indeed,  much  to  be  learned  from 
the  relative  amount  of  imports  and  exports  of  goods. 
The  old  interpretation,  however,  is  proved  to  have  no 
truth. 

This  does  not  answer  the  question  of  the  actual 
making  up  of  the  balance.  If  gold  does  not  supply 
the  difference,  how  is  it  supplied?  There  are  many 
factors  to  be  considered.  In  the  first  place,  we  must 
note  the  services  rendered  by  one  country  to  another 
in  transport.  Before  the  war  a  very  large  portion 
of  the  carrying  trade  of  the  world  was  performed 
by  Great  Britain.  Britain  was  always  in  a  condition 
of  "  adverse  balance,"  and  the  goods  which  were 


INTERNATIONAL  TRADE  267 

imported  over  and  above  the  exports  in  part  paid  for 
the  freight  charges  which  her  shipowners  levied  on 
the  carrying  of  goods.  It  has  been  estimated  that 
the  carrying  trade  of  Great  Britain  was  responsible  for 
imports  to  the  extent  of  nearly  $500,000,000  annually. 

Again  loans  are  constantly  in  process  from  one 
country  to  another.  Merchants  and  capitalists  of 
one  country  invest  in  the  securities  of  another  country. 
French  capitalists  held  the  great  bulk  of  the  Russian 
loans.  American  securities  —  railroad  bonds,  for  ex- 
ample, are  quoted  on  all  the  European  exchanges. 
English  railroad  bonds  are  held  in  America.  Now 
when  an  Englishman  buys  Southern  Pacific  bonds  he 
does  not  pay  in  actual  money.  He  pays  (in  the  manner 
which  will  be  detailed  in  our  next  chapter)  in  reality 
by  sending  goods  to  America.  There  is  no  immediate 
and  obvious  per  contra  to  this  import  of  British  goods, 
but  ultimately  the  loan  has  to  be  returned,  and  each 
year  the  dividends  must  be  paid,  and  these  return 
payments  mean  the  export  of  American  goods  to  Great 
Britain. 

Still  further,  the  governments  of  countries  must 
maintain  staffs  of  consuls  and  ambassadors  abroad. 
The  payment  of  these  representatives  and  their  expendi- 
ture in  the  countries  in  which  they  reside  necessitate 
an  export  of  goods  from  the  country  whose  govern- 
ment they  represent.  Tourists,  also,  making  use  of 
travelers'  checks,  are  causing  a  flow  of  goods  from 
their  home  country.  When  one  country  pays  an 
indemnity  to  another,  or  buys  a  piece  of  territory  (as 
when  this  country  purchased  Alaska)  goods  are  ex- 
ported to  furnish  the  payment. 


268  AN    INTRODUCTION   TO   ECONOMICS 

There  are  other  factors,  but  we  have  enumerated 
sufficient  to  show  that  the  balance  is  restored  by 
indebtedness  which  is  not  obvious  in  the  trade  returns. 
These  purchases  of  securities,  lending  of  shipping 
services,  payments  of  consuls,  and  so  on,  may  be 
regarded  as  invisible  exports  and  imports,  as  contrasted 
with  the  visible  imports  and  exports  of  goods.  The 
visible  and  invisible  exports  of  a  country,  which  repre- 
sent its  indebtedness  to  other  countries,  are  balanced 
by  the  visible  and  invisible  imports  of  the  country, 
which  represent  the  indebtedness  of  other  countries 
to  the  first.  Instead  of  a  balance  of  trade,  therefore, 
what  we  have  is  an  equation  of  indebtedness,  which 
is  a  totally  different  thing. 

The  whole  question  is  obscured  by  the  apparent 
lack  of  connection  between  the  lenders  who  purchase 
securities,  and  the  exporter  of  the  goods  which  really 
pay  for  the  securities.  This  matter  will  be  made 
clearer  in  our  next  chapter. 


CHAPTER  XXI 

DOMESTIC  AND   FOREIGN  EXCHANGE 

Difficulties  in  Paying  by  Check  —  The  purpose 
of  this  chapter  is  to  discuss  the  mechanism  of  payments 
made  over  a  long  distance.  In  a  small  country  like 
Great  Britain,  for  instance,  payments  within  the 
country  can,  as  a  rule,  be  readily  made  by  means  of 
the  check  of  the  payer.  If  a  merchant  in  London 
desires  to  pay  for  goods  bought  from  a  Glasgow  firm, 
all  he  has  to  do  is  to  send  his  check  for  the  amount. 
The  Glasgow  merchant  will  then  deposit  the  check 
in  his  bank  for  collection. 

This  method  is  possible  also  in  America,  but  it  is  not 
so  satisfactory.  The  country  is  so  large  that  there 
is  necessarily  a  considerable  period  of  waiting  to  be 
done  before  a  check  drawn  on,  let  us  say  a  Los  Angeles 
bank,  can  be  paid  in  New  York.  The  New  York 
bank  does  not  know  the  drawer  of  the  check  and 
consequently  will  not  pay  the  amount  called  for  on 
presentation  of  the  check.  He  will  send  it  first  to 
his  Los  Angeles  correspondent  for  collection.  This 
takes  time,  and  the  merchant  to  whom  the  payment 
is  due  hardly  cares  to  wait  until  collection.  He  wants 
his  money  at  once.  The  Los  Angeles  merchant,  there- 
fore, must  provide  some  other  means  of  payment. 
This  illustrates  the  difficulty  of  making  payments 
over  a  long  distance.  Domestic  exchange,  as  the 
269 


270  AN   INTRODUCTION   TO   ECONOMICS 

actual  system  is  called,  is  similar  in  all  essentials 
to  foreign  exchange.  The  only  important  difference 
that  exists  between  the  two  is  due  to  the  fact  that, 
as  a  rule,  there  are  different  currency  systems  in  dif- 
ferent countries.  This  complicates  the  question,  with- 
out altering  the  fundamentals.  Let  us  first  consider 
the  question  of  domestic  exchange. 

Gold  or  Currency  Payments  —  There  is  always 
the  possibility  of  sending  actual  currency  in  payment 
of  debts.  Our  Los  Angeles  merchant,  for  example, 
might  send  to  New  York  the  necessary  amount  in 
gold  or  currency.  This  necessitates  a  certain  expense, 
however,  for  one  cannot  ship  currency  without  pay- 
ing for  transportation  charges.  In  reality  there  are 
three  items  in  the  expense  of  a  currency  shipment. 
First  there  is  the  actual  expense  of  transportation  — 
the  freight,  as  it  were;  second,  there  is  the  cost  of 
insuring  the  money ;  finally  there  is  the  loss  of  interest 
on  the  currency  during  its  transport.  For  example, 
if  a  shipment  of  $10,000  is  made  from  Los  Angeles 
to  New  York,  it  will  take  about  five  days  to  reach 
its  destination.  That  means  that  the  merchant  who 
,has  made  the  shipment  will  have  to  remove  the  cur- 
rency from  the  bank,  or  other  place  where  it  is  earning 
interest,  five  days  before  he  would  have  to  do  so,  if 
the  payment  were  to  be  made  in  his  own  city.  There- 
fore he  loses  that  five  days'  interest,  and  consequently 
the  amount  of  the  loss  must  be  charged  to  the  cost  of 
the  shipment. 

If  gold  is  used,  there  will  be  a  drain  of  gold  to  the 
extent  of  that  payment  from  the  transmitting  city. 
Naturally,  however,  the  shipments  are  not  all  in  the 


DOMESTIC  AND  FOREIGN  EXCHANGE          271 

same  direction,  or  else  the  city  which  sends  out  the 
gold  would  soon  have  none  left.  Payments  are  not 
only  made  by  the  merchants  of  a  city,  but  to  them  as 
well.  Hence  there  will  be  a  certain  amount  of  cross 
shipping,  gold  and- currency  leaving  the  city  and  gold 
and  currency  entering  it. 

As  we  have  already  seen  in  our  discussion  of  the 
checking  system,  this  involves  a  great  waste  of  cur- 
rency. The  currency  is  idle  while  in  transport.  Not 
only  is  it  not  being  used  for  payments  during  the 
interval,  but  it  cannot  be  used  as  a  basis  for  credit 
money  to  be  issued.  From  every  point  of  view,  there- 
fore, such  a  method  is  wasteful. 

Payment  by  Draft  —  The  difficulty  is  very  largely 
solved  by  means  of  the  banking  system.  Each  com- 
munity has  some  central  town  or  city  which  has  rela- 
tions with  all  parts  of  that  community.  In  California, 
for  instance,  every  town  has  direct  commercial  rela- 
tions with  San  Francisco.  Every  bank  will  have 
business  dealings  with  the  banks  in  the  central  city 
of  the  community.  In  a  similar  way,  every  town  of 
any  importance  in  the  country  has  definite  business 
relations  with  New  York,  which  is  the  money  center 
for  the  whole  country.  The  relation  between  the 
banks  of  one  city  and  another  is  known  as  the  relation 
between  correspondent  and  agent.  If  the  First  Na- 
tional Bank  of  San  Francisco  deals  directly  with  the 
National  City  Bank  of  New  York,  it  regards  the  latter 
as  its  correspondent.  If  the  New  York  bank  sends 
its  checks  drawn  on  San  Francisco  to  the  First  National 
for  collection,  then  the  First  National  is  the  agent 
of  the  National  City  Bank. 


272  AN  INTRODUCTION  TO  ECONOMICS 

The  First  National,  in  order  to  use  the  National 
City  Bank  as  its  correspondent,  deposits  funds  with 
the  New  York  bank  in  the  same  way  in  which  a  private 
firm  deposits  its  funds  in  the  local  bank.  Let  us 
suppose,  now,  that  the  First  National  of  San  Francisco 
has  on  deposit  with  the  National  City  Bank  the  sum 
of  $100,000.  If  a  merchant  in  the  Pacific  city  wishes 
to  make  a  payment  in  New  York,  he  has  three  choices 
open  to  him.  He  may  ship  currency,  he  may  draw 
a  check  on  his  bank  and  send  it  in  payment,  or  he  may 
buy  exchange.  The  latter  is  the  usual  method.  To 
do  this,  he  goes  to  the  First  National  and  asks  for  a 
"  draft  "  on  New  York,  for  a  certain  sum.  He  pays 
for  this  draft  and  the  banker  hands  him  what  is,  to 
all  intents  and  purposes,  a  check  drawn  upon  the 
National  City  Bank.  When  that  check  or  draft 
arrives  in  New  York,  the  bank  there  charges  it  against 
the  deposit  credit  of  the  San  Francisco  bank  and  pays 
the  check  just  as  it  would  pay  a  check  drawn  on  a 
neighboring  bank  or  upon  itself. 

The  banker  does  not  sell  this  draft  out  of  pure 
kindness  of  heart ;  he  makes  a  charge  for  his  services. 
There  is  a  limit  to  the  amount  he  can  charge,  however. 
The  cost  of  shipping  currency  from  the  Pacific  Coast 
to  New  York  is  about  $1.50  per  $1000.  The  actual 
cost  will  vary,  of  course,  according  to  the  rate  of 
interest.  If  the  bank  charges  more  than  that  amount 
for  its  draft,  it  will  pay  the  merchant  to  ship  currency. 
Hence,  if  the  bank  wishes  to  do  business  at  all,  it 
must  keep  its  charges  for  exchange  below  the  cost 
of  shipping  currency.  The  point  at  which  it  pays 
to  ship  currency  is  commonly  called  the  "  gold  point." 


DOMESTIC  AND  FOREIGN   EXCHANGE          273 

These  transactions  are  not  all  one  way.  Just  as 
there  are  payments  to  be  made  in  New  York,  so  there 
are  payments  to  be  made  by  New  York.  The  National 
City  Bank,  for  instance,  may  have  drafts  drawn  on 
San  Francisco  sent  to  it  to  be  collected.  These  drafts 
it  forwards  to  the  First  National  for  collection  and 
immediately  sells  its  own  drafts  on  San  Francisco 
to  be  paid  for  by  the  money  collected  in  the  San 
Francisco  institution. 

This  is  simple  enough,  of  course,  if  we  deal  only  with 
the  two  cities.  But  all  payments  are  not  made  to  or 
by  New  York.  What  happens  when  a  payment  has  to 
be  made,  let  us  say  between  Peoria,  Illinois,  and  Seattle, 
Washington  ?  It  is  not  to  be  supposed  that  the 
Peoria  bank  carries  deposits  in  the  Seattle  bank,  or 
vice  versa.  Suppose  a  Seattle  merchant  wishes  to 
make  a  payment  in  Peoria.  He  asks  his  bank  for  a 
draft.  The  Seattle  bank,  thereupon,  sells  him  a 
draft,  not  on  Peoria,  but  on  New  York.  New  York 
exchange  is  always  acceptable,  owing  to  the  vast 
number  of  transactions  with  that  city.  The  Peoria 
bank  is  perfectly  willing  to  cash  the  draft,  for  it 
knows  that  it  can  deposit  the  draft  with  its  own  New 
York  correspondent  and  sell  New  York  exchange  itself. 

This  method  of  settling  payments  over  a  distance 
is  one  of  the  commonest.  There  is  another  method, 
by  use  of  the  discount  system,  with  which  we  shall 
deal  fully  in  considering  foreign  exchange.  Before 
we  do  so,  however,  we  must  deal  with  the  question 
of  the  relations  between  different  coinages. 

Mint  Par  of  Exchange  —  In  order  to  simplify  the 
discussion,  we  shall  consider  only  two  coinages,  for 


274  AN    INTRODUCTION  TO  ECONOMICS 

the  principles  involved  are  the  same  no  matter  how 
many  we  examine.  There  are  minor  difficulties,  of 
course,  but  these  can  only  be  dealt  with  in  a  much 
fuller  treatment  than  is  possible  here.  The  British 
currency  is,  like  the  American,  on  a  gold  basis.  The 
sovereign  consists  of  a  certain  weight  of  gold.  So 
does  the  dollar.  If  an  English  sovereign  were  to  be 
recoined  into  American  money,  the  coin  would  be  of 
the  value  of  $4.8665.  That  is  to  say,  there  is  as  much 
pure  gold  in  an  English  sovereign  as  there  is  in  an  Amer- 
ican coin  (if  one  were  actually  coined)  worth  four  dol- 
lars and  eighty -six  and  two  thirds  cents.  The  equiva- 
lent is  known  as  the  Mint  Par  of  Exchange,  or  simply, 
the  mint  par.  It  is  around  this  figure  that  the  price 
of  the  English  sovereign,  in  terms  of  dollars  and  cents, 
will  fluctuate. 

If,  for  instance,  an  American  merchant  owes  £1000 
payable  in  London  and  wishes  to  make  payment  in 
gold,  he  must  send  gold  to  the  value  of  $4866.50  to 
England.  But  that  amount  of  gold,  sent  to  England, 
will  cost  him  more  than  the  $4866.50.  There  will  be 
the  expense  of  assaying  the  gold  to  determine  its 
purity.  There  will  also  be  the  cost  of  packing  and 
freight.  The  shipment  will  have  to  be  insured,  and 
while  on  the  voyage  no  interest  will  be  earned.  The 
gold  will  be  out  of  his  hands  from  seven  to  ten  days 
and  consequently  the  shipper  will  not  be  able  to  loan 
the  money  for  that  period,  or  he  must  take  the  cash 
from  some  investment  seven  or  ten  days  earlier  than 
would  be  necessary  if  the  debt  were  to  be  paid  at 
home. 

If  he  can  buy  a  draft  on  London,  in  the  same  way 


DOMESTIC  AND  FOREIGN  EXCHANGE          275 

as  he  would  a  draft  on  New  York,  and  the  cost  of 
buying  such  a  draft  is  less  than  the  cost  of  packing, 
shipping,  insuring,  etc.,  the  shipment  of  gold,  he  will 
buy  the  draft. 

The  same  is  true  in  the  case  of  a  debt  due  by  an 
Englishman  to  an  American  merchant.  If  the  cost 
of  the  draft  is  higher  than  the  cost  of  gold  shipment, 
the  gold  will  be  sent.  Otherwise  the  draft  will  be 
used.  The  cost  of  sending  gold,  therefore,  limits 
the  amount  which  may  be  charged  for  drafts.  If 
we  say  that  the  cost  of  shipping  gold  amounts  to  two 
cents  per  sovereign,  then  gold  will  be  shipped  from 
America  when  the  charge  for  drafts  is  greater  than 
$4.8865.  Gold  will  be  imported  when  the  price  of 
the  sovereign  goes  down  below  $4.8465. 

The  two  points  at  which  gold  is  shipped  are  known 
as  the  gold  points.  The  principle  upon  which  the 
theory  of  the  gold  movements  is  based  is  very  simple. 
The  merchant  who  is  desirous  of  making  a  payment 
wants  to  make  that  payment  as  easily  as  possible. 
He  has  a  debt  of  a  certain  amount  to  pay,  and  it 
costs  him  something  to  make  the  payment.  He 
naturally,  therefore,  chooses  the  method  of  making 
the  payment  which  will  cost  him  the  least. 

In  actual  practice,  however,  there  are  difficulties 
which  take  away  a  good  deal  of  the  simplicity  of  the 
process.  For  example,  the  gold  points  do  not  always 
work  out  as  easily  as  we  have  suggested.  There  is 
still  a  strong  belief  in  many  countries  that  gold  possesses 
peculiar  properties.  It  is  regarded  as  a  kind  of  insignia 
of  wealth.  There  is,  therefore,  a  great  reluctance  to 
permitting  any  gold  to  leave  the  country.  Difficulties 


276  AN   INTRODUCTION  TO  ECONOMICS 

are  placed  in  the  way  of  the  exporter  which  increase 
his  expenses.  In  some  cases,  for  instance,  a  premium 
is  charged  for  purchasing  gold  for  export.  This  at 
once  raises  the  gold  point  beyond  the  height  reached 
by  adding  the  cost  of  transportation,  interest,  etc., 
to  the  value  of  the  gold.  Governments  occasionally 
prohibit  the  export  of  gold  and  hence  gold  shipments 
become  impossible.  Again,  in  the  United  States 
gold  is  not  the  only  lawful  money,  as  it  is  in  England 
(with  the  exception  of  some  wartime  currency). 
Hence  the  merchant  cannot  always  depend  upon 
getting  gold  without  considerable  difficulty,  all  of 
which  is  expensive.  Before  the  war  Great  Britain 
was  practically  the  only  country  in  the  world  in  which 
gold  could  be  obtained  without  any  restriction.  Theo- 
retically no  change  has  been  made  in  regard  to  Great 
Britain's  position;  there  is  no  law  or  regulation  for- 
bidding the  export  of  gold.  As  a  matter  of  fact,  how- 
ever, those  in  authority  in  the  treasury  in  London 
have  not  looked  favorably  on  any  suggestion  to  export 
gold.  Bankers  have  been  unwilling  to  offend  the 
treasury,  for  obvious  reasons,  and  hence  the  same 
result  is  effected  as  if  there  were  definite  obstacles 
placed  by  government  against  export. 

Method  of  Paying  for  Foreign  Goods  —  So  far, 
we  have  dealt  with  the  principles  merely.  We  shall 
now  turn  to  the  actual  practice,  in  order  to  obtain 
a  clear  idea  of  the  causes  of  fluctuation  in  the  rates 
at  which  foreign  money  is  bought  and  sold. 

Let  us  consider  the  case  of  an  American  merchant 
who  has  bought  some  Chinese  silk.  He  desires  to 
have  that  silk  and  dispose  of  it  on  the  market  before 


DOMESTIC  AND  FOREIGN  EXCHANGE          277 

he  makes  payment  to  the  Chinese  merchant  from 
whom  he  bought  it.  The  Chinese  merchant  may  be 
willing  to  offer  him,  say,  sixty  days'  credit.  How  is 
he  to  pay?  The  payment  cannot  be  made  in  the 
simple  fashion  of  buying  a  draft  on  a  Chinese  bank 
from  an  American  bank.  As  a  rule  American  banks 
do  not  maintain  deposits  with  banks  in  China.  The 
method  is  a  little  more  complicated.  Just  as  in  domes- 
tic exchange  every  one  is  willing  to  take  drafts  on  New 
York,  so  in  foreign  exchange,  drafts  on  London  are 
always  desired. 

At  the  outset  of  his  dealings  with  the  Chinese  mer- 
chant, the  American  will  have  to  establish  his  credit 
before  he  can  obtain  goods.  The  Chinese  merchant 
as  a  rule  will  ask  to  receive  what  payment  is  due  by 
bills  on  London.  The  American  therefore  arranges 
to  pay  him  in  this  way.  He  approaches  his  own  banker 
and  describes  the  nature  of  the  transaction  upon 
which  he  is  about  to  engage.  If  the  banker  is  satisfied, 
he  agrees  to  open  a  credit  for  the  merchant  for  the 
necessary  amount,  which,  we  may  say,  is  for  $10,000. 
Put  into  English  money,  this  will  amount  to  (roughly) 
£2000.  The  banker  instructs  his  correspondent  in 
London  (that  is  a  bank  in  London  with  whom  he  is 
in  the  habit  of  doing  business  and  maintaining  deposits) 
to  open  a  credit  to  the  extent  of  £2000  in  favor  of  the 
Chinese  merchant.  The  Chinese  merchant  will,  in 
due  course,  receive  from  the  London  correspondent 
a  letter  somewhat  like  the  following : 


278  AN   INTRODUCTION   TO   ECONOMICS 

LONDON,  January  1,  1919. 
MESSRS.  LEE  WONG  &  Co., 

SHANGHAI,  CHINA. 
Dear  Sirs, 

We  hereby  beg  to  confirm  to  you  Credit  No.  65  opened 
with  us  in  your  favor  by  Messrs.  John  Robinson  &  Company, 
of  New  York  for  £2000  (say  two  thousand  pounds  sterling) 
for  which  amount  we  shall  duly  honor  your  drafts  at  sixty 
days'  sight  drawn  in  Shanghai.  This  credit  expires  unless 
previously  canceled  on  January  1,  1920. 

All  drafts  against  this  credit  must  be  drawn  and  duly 
advised  to  us  before  that  date,  and  must  be  accompanied  by 

Consular  Invoice. 
Bills  of  Lading. 
Insurance  Certificate. 

Please  insert  in  your  drafts  the  number  and  date  of  the 
credit  and  the  initials  of  the  firm  by  whom  you  are  accredited. 
A  copy  of  the  advice  to  be  attached  to  each  draft  drawn  under 
this  credit. 

Yours  truly, 

THE  LONDON  CITY  AND  MIDLAND-  BANK. 
£2000.  o.  o.  No. 


There  are  some  items  mentioned  in  this  letter  which 
require  explanation.  The  value  of  the  goods  imported 
into  a  foreign  country  is  usually  certified  to  the  consul 
of  that  country  at  the  place  of  entry.  The  consul 
then  signs  an  invoice  showing  the  amount.  This  is 
known  as  the  consular  invoice.  It  frequently  happens 
that  before  goods  imported  from  a  foreign  country 
can  be  received  by  the  importer  from  the  ship  the 
importer  must  show  to  the  customs  authorities  the 


DOMESTIC  AND  FOREIGN  EXCHANGE          279 

consular  invoice  of  the  goods.  The  consular  invoice, 
therefore,  is  one  of  the  documents  necessary  to  the 
importer.  Again,  when  the  goods  are  shipped,  the 
shipper  receives  from  the  transportation  company 
what  is  practically  a  receipt  for  the  goods.  This 
receipt  is  known  as  a  bill  of  lading.  The  importer 
of  the  goods  must  show  to  the  agents  of  the  steariiship 
some  authority  for  his  statement  that  the  goods  belong 
to  him.  Naturally  a  steamship  company  will  not 
hand  goods  to  any  one  who  claims  possession.  The 
documents  which  the  steamship  company  recognizes 
as  constituting  title  to  the  goods  are  the  bills  of  lad- 
ing. In  case  of  loss  of  the  goods,  the  value  can  only 
be  recovered  from  the  insurance  company  by  the 
person  who  possesses  the  policy  or  certificate  of  insur- 
ance. Hence  this  certificate,  also,  forms  one  of  the 
necessary  documents.  In  order,  therefore,  for  the 
importer  to  obtain  his  goods,  he  must  be  able  to  show 
title  by  presenting  these  evidences  that  the  goods  are 
intended  for  him. 

Now  let  us  turn  to  the  position  of  the  Chinese  mer- 
chant. He  receives  the  letter  of  credit  in  due  course 
and  has  the  goods  ready  for  shipment .  Before  shipping, 
he  obtains  from  the  United  States  consul  in  Shanghai 
a  consular  invoice  for  the  goods.  This  he  makes  out 
himself  and  certifies,  the  consul  signing  the  certificate. 
Then  he  sends  the  goods  to  the  steamer  and  receives 
the  bills  of  lading.  At  the  same  time  he  insures  the 
goods  with  some  marine  insurance  company  or  broker 
and  obtains  the  policy. 

When  he  has  these  necessary  documents,  he  draws 
a  draft  somewhat  as  follows  : 


280  AN    INTRODUCTION  TO  ECONOMICS 

JANUARY  21,  1919 
To  the  LONDON  CITY  AND  MIDLAND  BANK,  LONDON 

Pay  to  my  order  sixty  days  after  sight,  the  sum  of  two 
thousand  pounds  sterling  (£2000.  o.  o.).     Second  and  third 
of  same  tenor  and  date  unpaid. 
£2000.  o.  o.       65.  J.  R:  &  Co.  LEE  WONG  &  Co. 

To  this  draft  he  attaches  the  three  documents 
already  mentioned.  The  draft  is  now  known  as  a 
documented  draft.  Lee  Wong  and  Company,  how- 
ever, do  not  wish  to  wait  for  sixty  days  before  receiving 
payment.  Neither  do  they  wish  for  the  actual  cur- 
rency in  English  money.  They  take  the  documented 
draft  to  their  own  bank  in  Shanghai  together  with 
the  letter  of  credit.  This  letter  is  evidence  to  the 
bank  that  the  company  has  been  authorized  to  draw 
upon  the  London  bank.  The  Shanghai  bank  dis- 
counts the  draft,  giving  the  equivalent  of  the  face 
value,  less  the  deducted  interest  or  discount,  to  Lee 
Wong  and  Company,  in  Chinese  currency.  Lee  Wong 
and  Company  are  now  out  of  the  transaction.  They 
'have  received  payment  for  their  goods  and  are  satisfied. 
But  Robinson  and  Company,  of  New  York,  have  not 
paid  yet,  so  we  must  follow  the  draft  a  little  further. 

The  Shanghai  bank  forwards  the  draft,  with  its 
attached  documents,  to  its  London  correspondent, 
which  is,  let  us  say,  Parr's  Bank.  Parr's  Bank,  when 
they  receive  the  documented  draft,  forward  both  to 
the  London  City  and  Midland  Bank  for  "  acceptance." 
The  latter  writes  across  the  face  of  the  draft  the  words 
"  Accepted,  February  25,  1919,"  and  signs  the  draft. 
The  bank  official  detaches  the  documents  and  returns 


DOMESTIC  AND  FOREIGN  EXCHANGE          281 

the  draft  (which  is  now  called  an  acceptance),  hands  the 
draft  to  the  representative  of  Parr's  Bank  and  forwards 
the  documents  to  the  New  York  bank  which  had 
opened  the  credit  on  behalf  of  Robinson  and  Com- 
pany. The  latter  hands  the  documents  to  Robinson, 
so  that  he  can  obtain  the  goods. 

Meanwhile,  Parr's  Bank  will  obtain  actual  cash  for 
the  acceptance  by  selling  it  in  the  discount  market,  that 
is,  selling  it  to  one  of  those  firms  whose  business  it  is 
to  invest  money  for  short  periods  by  purchasing  such 
drafts. 

The  money  obtained  by  the  sale  of  the  acceptance 
is  placed  to  the  credit  of  the  Shanghai  bank,  which 
is  now  able  to  sell  drafts  on  London  to  Chinese  mer- 
chants who  have  payments  to  make  in  English  money. 

We  have  now  reached  the  point  where  the  Chinese 
merchant  has  received  his  money  and  Robinson  and 
Company  have  received  the  documents  entitling  them 
to  the  possession  of  the  shipment  of  silk.  The  latter 
obtain  the  goods  and  sell  them  in  the  American  market. 
Meanwhile  the  sixty-day  period  mentioned  in  the  draft 
is  drawing  to  a  close.  Before  the  time  is  up,  Robinsons 
will  have  sold  the  bulk  of  the  goods.  They  pay  the 
New  York  bank  which  opened  the  credit  for  them. 
The  bank  thereupon  forwards  the  necessary  amount 
to  the  London  City  and  Midland  Bank  in  time  to 
reach  that  bank  on  or  before  the  date  of  maturity  of 
the  draft.  On  the  day  of  maturity,  that  is,  sixty  days 
after  the  word  accepted  was  written  across  the  draft,  the 
holder  of  the  draft  presents  it  to  the  London  City 
and  Midland  Bank  for  payment.  The  latter,  having 
received  funds  from  New  York,  pays  the  draft  and  the 


282 


AN   INTRODUCTION  TO   ECONOMICS 


whole  transaction  is  finished.  Only  one  thing  remains 
to  be  said :  How  does  the  New  York  bank  send  the 
amount  to  London  ? 

The  probability  is  that  the  New  York  bank  has 
bought  drafts  on  London  from  American  merchants 
who  have  English  debts  due  to  them,  and  sends  these 
drafts  to  the  London  City  and  Midland  Bank.  The 
latter  can  then  cash  the  drafts  and  from  the  proceeds 
pay  the  debt  due  on  the  acceptance  based  on  the  silk 
transaction. 

The  accompanying  diagram,  Fig.  7,  will  help  to 
explain  the  method  which  has  just  been  described. 


FIG.  7 


FOR   AMERICAN  PUR  C  HASE  OF  FORE  1C  N    GOODS. 


The  reverse  transaction,  the  payment  by  a  foreigner 
for  goods  bought  from  an  American,  may  be  made 
in  the  same  manner.  There  is,  however,  a  simpler 
method  which  is  coming  into  practice.  Suppose 
a  Stockholm  merchant  desires  to  pay  for  goods  bought 
in  America.  He  arranges  with  his  Stockholm  bank 
to  open  a  credit  for  him  in  New  York.  This  the  latter 


DOMESTIC  AND  FOREIGN   EXCHANGE  283 

does  by  buying  drafts  on  New  York  or  in  various 
other  ways  with  which  we  cannot  deal.  The  merchant 
now  has  what  amounts  to  a  deposit  credit  in  New 
York.  He  draws  his  drafts  or  checks  against  this 
credit  and  forwards  them  direct  to  his  New  York 
creditor.  The  latter  deposits  the  checks  in  his  own 
bank  and  the  transaction  is  settled. 

It  should  now  be  clear  to  the  student  that  there  is 
a  great  deal  of  purchase  and  sale  of  debts  due  in  foreign 
countries.  The  banks  which  deal  in  foreign  exchange 
constantly  purchase  from  merchants  the  drafts  which 
they  have  drawn  upon  their  foreign  debtors.  These 
are  sent  to  correspondent  banks  in  the  foreign  countries 
and  then  drafts  are  sold  to  Americans.  There  is  a 
definite  charge  made  for  each  transaction,  however. 
Assuming  that  all  bills  are  of  the  same  length  of  time, 
the  charge  will  to  a  large  extent  be  governed  by  the 
amount  of  "  commercial  bills,  "  as  the  drafts  we  have 
been  discussing  are  called,  that  happen  to  be  in  the 
market.  If  a  banker  finds  it  difficult  to  obtain  bills 
drawn  on  London,  for  instance,  he  raises  his  price 
to  the  seller.  But  as  he  has  to  pay  a  higher  rate  for 
the  drafts  he  purchases,  he  must  charge  a  higher 
rate  for  the  drafts  he  sells.  The  smaller  the  number 
of  commercial  bills  in  the  market,  the  higher  will  be 
their  price,  or,  in  other  words,  the  lower  will  be  the 
rate  of  discount,  and  the  higher  will  be  the  price  of 
drafts  sold  by  the  bank.  That  is,  if  an  American 
bank  finds  that  it  has  to  pay  a  high  price  for  drafts 
on  London,  when  selling  drafts  against  the  deposit 
credit  he  has  built  up  in  London,  he  will  ask  more 
dollars  and  cents  a  pound  sterling. 


284  AN   INTRODUCTION   TO   ECONOMICS 

Finance  Bills  —  The  bankers  are  not  entirely  de- 
pendent upon  commercial  bills,  however.  There  are 
ways  of  manufacturing  bills  which  have  nothing  to 
do  with  commercial  transactions.  Suppose  that  the 
number  of  drafts  drawn  upon  London,  and  based 
upon  commercial  transactions  which  involved  sales 
of  goods  to  English  or  other  foreign  merchants,  happens 
to  be  small.  And  suppose  that,  at  the  same  time, 
the  demands  for  London  exchange  (or  sterling  exchange, 
as  it  is  called)  are  large.  Where  are  the  bankers  to 
find  the  means  of  adding  to  their  deposits  in  London 
so  that  they  may  sell  sterling  exchange  ?  They  arrange 
to  borrow  from  the  London  banks  and  to  have  the  loans 
placed  to  their  credit  in  those  banks.  They  then  sell 
drafts  against  the  new  deposits,  relying  upon  being 
able  either  to  buy  commercial  bills  to  repay  the  bank 
in  London,  or  else  to  renew  the  loan  at  maturity. 
Such  bills,  based  upon  loans  made  by  the  London 
banks,  are  termed  finance  bills,  and  they  are  of  great 
value  in  keeping  the  rate  of  exchange  steady,  or  at 
least  in  preventing  undue  fluctuation. 

Effect  of  the  Time  Element  on  the  Price  of  Exchange 
—  All  bills  are  not  of  the  same  length  of  maturity. 
Some  are  drawn  at  sight,  some  at  thirty  days,  some 
at  sixty,  and  so  forth.  Some  drafts  are  sold  on  the 
understanding  that  the  amount  to  be  paid  in  the 
foreign  country  shall  be  telegraphed  to  the  paying 
bank  so  that  the  transfer  of  the  money  shall  be  practi- 
cally immediate.  These  latter  are  known  as  telegraph 
or  cable  transfers.  Now  obviously,  when  there  is  a 
period  of  time  to  elapse  before  the  actual  payment 
is  made,  the  question  of  the  rate  of  interest  becomes 


DOMESTIC  AND  FOREIGN  EXCHANGE          285 

important.  The  possession  of  a  draft  on  a  bank  carries 
the  title  to  money.  But  we  have  already  seen  that 
there  is  a  different  marginal  utility  in  regard  to  present 
and  future  goods.  Hence,  a  man  who  has  a  draft  for 
$1000  will  think  himself  better  off  if  the  draft  calls 
for  immediate  payment  than  if  it  calls  for  payment 
in  sixty  days.  He  will,  therefore,  be  willing  to  pay 
more  for  money  immediately  available  than  for  money 
at  some  future  date.  The  rate  for  cable  transfers 
is,  as  a  consequence,  higher  than  for  sight  drafts, 
which,  in  the  case  of  American  bills  drawn  on  London, 
means  a  delay  of  about  ten  days  before  payment  can 
be  made.  Sight  drafts  will  be  higher  than  thirty 
or  sixty-day  paper,  and  so  on. 

The  rate  of  exchange  between  two  countries,  then,  is 
not  a  single  rate,  but  varies  according  to  the  length 
of  the  maturity  of  the  drafts.  In  any  table  of  exchange 
rates  it  will  be  seen  that  a  series  of  rates  is  given  for 
each  country  mentioned  in  the  list. 

Effects  of  the  Rate  of  Interest  upon  Exchange  Rates 
—  Ignoring  differences  in  the  length  of  time  at  which 
the  drafts  mature,  there  remains  to  be  considered 
the  effect  of  changes  in  the  rate  of  interest  upon  the 
exchange  rate.  If  interest  rates  in  London  are  high, 
American  foreign  exchange  bankers  will  be  anxious 
to  take  advantage  of  those  high  rates  and  to  increase 
their  deposits  in  London.  To  do  this,  they  must 
buy  drafts  that  are  drawn  on  London.  The  increased 
demands  for  those  drafts  raises  their  price.  A  high 
rate  of  interest  in  London  means  a  high  price  for 
commercial  bills  drawn  on  London.  As  soon,  how- 
ever, as  the  increased  deposits  in  London  have  reached 


286  AN   INTRODUCTION   TO   ECONOMICS 

the  point  at  which  the  supply  of  loanable  funds  or 
credit  in  London  is  great  enough  to  cause  a  fall  in 
interest  rates,  the  demand  for  bills  drawn  on  London 
will  decrease,  and  hence  the  price  for  them  will  fall. 

The  Causes  of  Gold  Movements  —  We  have  seen 
above  that  the  increase  in  the  interest  rates  abroad 
causes  a  rise  in  price  of  commercial  bills  drawn  on 
the  foreign  countries.  As  the  reason  for  this  increase 
is  the  desire  of  the  bankers  to  increase  their  interest- 
earning  funds  abroad,  where  the  high  rate  obtains, 
they  will  only  sell  exchange  on  the  foreign  countries 
(that  is,  sell  drafts  drawn  upon  their  foreign  deposits) 
at  a  higher  rate.  If  that  rate  should  go  beyond  the 
gold  point,  there  will  be  shipments  of  gold.  A  certain 
class  of  banker  watches  these  interest  rates  very 
closely.  As  soon  as  it  becomes  profitable  for  him  to 
ship  gold  to  the  foreign  country  (or  to  import  gold  from 
abroad)  he  does  so.  The  actual  percentage  of  profit 
made  on  these  transactions  in  gold  is  very  small,  but 
the  large  amounts  of  gold  actually  shipped  make 
the  actual  amount  of  profit  sufficient  to  justify  a 
very  considerable  business.  Such  a  business  is  known 
as  arbitrage. 

Again,  it  must  be  remembered  that  America  is 
a  gold-producing  country  and  gold  takes  its  place 
with  ordinary  merchandise.  The  balance  of  trade, 
therefore,  has  nothing  whatever  to  do  with  gold  ship- 
ments, and  while  the  phrase  is  not  without  value 
in  the  estimation  of  the  trade  conditions  of  a  country, 
its  value  is  very  different  from  that  attached  to  it  by 
the  mercantilist  philosophers  who  originated  the 
phrase. 


.CHAPTER  XXII 

PROTECTION  AND   FREE   TRADE 

Definitions  of  Protective  and  Revenue  Taxation  — 
In  our  discussion  of  the  theory  of  international  trade 
we  considered  the  question  from  the  point  of  view 
of  free  competition.  This  was  necessary  in  order 
to  clear  the  ground  for  the  further  discussion  including 
those  factors  which  tend  to  modify  conclusions  drawn 
from  such  a  standpoint,  or,  in  other  words,  the  dis- 
cussion of  the  limitations  of  competition  between  na- 
tions caused  by  the  presence  of  hindrances  not  due 
to  natural  causes. 

We  shall,  in  the  present  chapter,  consider  some  of 
the  problems  caused  by  the  imposition  of  protective 
duties,  but  before  we  do  so  we  must  understand  exactly 
what  is  meant  by  protective  duties.  Some  of  the  factors 
dealt  with  in  the  present  discussion  are  also  included 
in  the  study  of  public  finance  —  a  study  which  will  be 
touched  upon  in  a  future  chapter,  but  it  is  sufficient, 
for  the  present,  if  we  understand  that  in  the  financial 
arrangements  of  a  country  other  questions  are  con- 
sidered besides  the  mere  collection  and  expenditure 
of  revenue.  Provisionally  we  may  say  that  taxes 
may  be  divided  into  two  parts,  the  first  including 
those  which  are  imposed  entirely  for  the  purpose  of 
providing  funds  to  carry  on  the  administration  of 
government,  and  the  second  containing  those  which 
•  287 


288  AN  INTRODUCTION  TO  ECONOMICS 

have  for  their  aim  the  regulation  or  stimulation  of 
industry,  and  whose  revenue-collecting  functions  are 
incidental. 

To  the  first  class  we  assign  the  term  revenue  duties, 
and  to  the  second,  protective  duties.  In  both  classes 
we  are  restricting  ourselves  to  the  consideration  of 
indirect  taxes ;  that  is,  taxes  whose  incidence  may  be 
shifted  several  times  before  the  final  tax  bearer  is 
reached.  Our  meaning  may  be  made  clearer  by  an 
illustration.  A  tax  on  tea  is  usually  paid  by  the 
importer,  but  he  adds  the  amount  of  the  tax  to  the 
price  he  charges  to  the  jobber.  The  latter  again 
includes  it  in  his  price  to  the  retail  dealer,  who  trans- 
fers it  to  the  consumer.  On  the  other  hand,  a  tax 
on  income  is  usually  paid  by  the  person  upon  whom 
it  is  levied,  i.e.,  the  person  in  receipt  of  the  income. 
The  latter  tax  is  direct  and  the  former  indirect. 

All  indirect  taxes  are  not  protective,  however. 
To  be  protective  the  tax  must  not  fall  on  all  the  goods 
which  form  its  subject.  For  revenue  purposes  the 
tax  should  fall  without  distinction  on  goods  produced 
within  the  country  and  similar  goods  imported  from 
other  countries.  The  protective  tax  falls  only  upon 
those  goods  which  are  of  foreign  origin.  Taxes  on 
liquor,  which  are  levied  on  imported  as  well  as  home- 
made liquor,  are  obviously  instituted  for  the  purpose 
of  gaining  revenue.  On  the  other  hand,  taxes  which 
are  imposed  upon  imported  steel  goods,  but  not  on 
steel  goods  manufactured  within  the  country,  are 
protective  duties.  There  is  a  definite  distinction  be- 
tween the  foreign  and  the  home  product,  and  the  ob- 
ject of  the  imposition  of  the  tax  is  not  primarily  the 


PROTECTION  AND  FREE  TRADE  289 

obtaining  of  revenues,  but  the  elimination  of  foreign 
competition  from  the  steel  manufacturing  business 
within  the  country. 

It  should  be  obvious  that  a  revenue  tax  does  not 
interfere  with  international  trade  as  far  as  freedom 
of  competition  is  concerned,  whereas  the  protective 
tax  is  designed  to  produce  such  interference,  in  order 
to  handicap  the  foreign  producer  and  prevent  him 
from  obtaining  the  fruits  of  his  comparative  advantage 
in  production. 

Effect  on  Prices  —  If  a  protective  duty  is  to  be 
of  value  to  an  industry  it  is  essential  that  it  should 
mean  a  rise  in  price  of  the  protected  articles.  If, 
under  free  competition,  a  price  is  reached,  we  know 
that  such  a  price  is  the  result  of  the  interplay  of  the 
laws  of  supply  and  demand.  The  price  of  foreign 
goods  introduced  into  a  country  cannot  be  greater 
than  that  of  those  produced  within  the  country,  for 
if  it  were  the  foreign  goods  would  not  be  sold  and 
they  would  soon  cease  to  be  imported.  On  the  other 
hand  the  price  of  the  home-produced  goods  cannot 
exceed  that  of  the  foreign  goods,  for  if  so,  the  home 
production  would  not  be  sold.  Hence  the  objection 
to  the  free  importation  of  foreign  goods  is  due  to  the 
supposition  that  the  price  resulting  from  free  compe- 
tition is  too  low  to  be  satisfactory  to  the  home  pro- 
ducer. 

If,  therefore,  the  protection  extended  by  the  imposi- 
tion of  duties  upon  imported  foreign  goods  does  not 
enable  the  home  producer  to  raise  his  price,  from  his 
point  of  view  there  is  no  good  result.  For  instance, 
if  the  price  for  a  certain  commodity  is  fixed  under  a 


290  AN  INTRODUCTION  TO  ECONOMICS 

system  of  free  competition,  at  $5  a  ton,  the  demand 
for  protection  against  foreign  imports  of  this  commodity 
must  be  due  to  the  belief  that  $5  a  ton  is  too  low 
to  be  sufficiently  remunerative  to  the  home  producer. 
If,  then,  a  protective  duty  of  $1  a  ton  is  imposed 
on  imports,  and  the  price  to  the  consumer  is  still  $5 
a  ton,  wherein  does  the  home  manufacturer  profit? 
He  is  no  better  off  than  before.  Obviously,  therefore, 
the  purpose  of  the  duty  is  to  enable  the  home  producer 
to  charge  a  higher  price  for  his  goods. 

It  would  seem  from  the  above  argument  that  the 
imposition  of  a  duty  which  was  so  high  that  it  pre- 
vented any  importation  of  the  taxed  commodity, 
would  raise  the  price  of  the  home  product  by  exactly 
the  amount  of  the  duty,  any  further  rise,  of  course, 
making  it  again  worth  while  for  the  foreigner  to  enter 
the  market.  This  is  not  necessarily  the  case,  however. 
We  may  distinguish  three  cases.  The  first  is  that 
in  which  the  duty  has  no  effect  whatever.  If  we  con- 
sider the  case  of  a  commodity  which  is  produced  as 
cheaply  at  home  as  abroad  (allowing  for  the  cost  of 
transportation  of  the  foreign  goods)  and  in  sufficient 
quantities  to  satisfy  the  home  market,  there  will  be 
no  reason  for  the  importation  of  that  commodity. 
The  price  will  be  decided  entirely  by  the  conditions 
of  the  home  market.  Any  duty  imposed  on  importa- 
tion, therefore,  will  have  no  effect  whatever  on  the 
price.  This  case  is  not  so  impossible  as  it  might 
appear.  "American  duties  have  been  demanded  and 
secured  against  the  importation  of  foreign  wheat 
and  meat  products.  But  as  these  goods  have  been 
produced  in  ample  quantities  for  the  home  market 


PROTECTION  AND  FREE   TRADE  291 

and  just  as.  cheaply  as  abroad,  the  imposition  of  the 
duties  has  been  without  effect  upon  prices. 

The  second  case  is  that  in  which  the  imposition  of 
the  duty  has  not  succeeded  in  preventing  importation 
of  the  foreign  product.  In  this  case,  the  consumer 
necessarily  pays  the  foreign  price  plus  the  exact  amount 
of  the  duty  for  any  foreign  product  he  may  buy. 
That  is  to  say,  the  difference  between  the  price  of  the 
home  product  and  the  net  price  received  by  the  for- 
eigner is  exactly  the  amount  of  the  duty.  This  does 
not  necessarily  mean  that  the  price  to  the  consumer 
has  been  increased  by  the  amount  of  the  duty.  It 
may  be  that  the  cost  of  production  of  the  foreign 
commodity  is  such  that  the  producer  can  reduce  his 
price  and  still  make  an  adequate  profit.  To  illustrate 
this  let  us  return  to  the  case  of  the  commodity  sold 
at  $5  a  ton  before  the  imposition  of  the  duty.  If 
a  specific  duty  of  $1  a  ton  is  imposed  upon  importa- 
tions, and  the  foreigner  cannot  reduce  his  own  price, 
the  new  price  to  the  consumer  will  be  $6  a  ton.  The 
foreign  goods  which  are  actually  imported  will  pay 
$1  a  ton  to  the  government.  But  suppose  that 
the  foreigner  can  sell  at  $4.50  a  ton  and  still  make 
a  satisfactory  profit?  In  that  case  he  may  reduce 
his  net  price  to  $4.50  and  send  in  the  goods.  The 
price  to  the  consumer  will,  therefore,  be  $5.50  and 
the  home  producer  cannot  exceed  that  price.  Hence, 
while  the  difference  between  the  net  price  of  the 
foreigner  and  the  price  charged  by  the  home  manu- 
facturer still  amounts  exactly  to  the  $1  of  duty  im- 
posed, the  actual  increase  in  price  to  the  consumer  is 
only  50  cents. 


292  AN  INTRODUCTION  TO  ECONOMICS 

The  third  case  to  be  considered  is  that  in  which  the 
importations  are  absolutely  prohibited.  Here  the 
probability  is  that  the  consumer  pays  an  additional 
price  amounting  practically  to  the  whole  of  the  duty. 

There  are  various  considerations  which  affect  the 
question  of  the  continuance  of  exports  after  an  import 
duty  has  been  charged.  Matters  of  freight,  for 
instance,  may  have  considerable  importance.  It  some- 
times happens  that  the  freight  charged  on  commodities 
imported  from  a  foreign  country  is  considerably  less 
than  the  amount  charged  for  transportation  within 
the  country.  Water  carriage  is  invariably  cheaper 
than  rail,  and  sometimes  special  considerations  allow 
of  a  great  reduction  even  in  water  carriage  rates. 
When  Great  Britain  imports  cotton  from  Galveston, 
the  steamers  are  often  glad  to  get  a  return  freight  even 
at  very  low  rates  in  order  to  prevent  the  necessity  of 
having  to  return  in  ballast.  Hence  a  rate  for  steel 
rails  to  Galveston  may  be  less  than  the  cost  of  carriage, 
and,  therefore,  considerably  less  than  the  cost  of  rail 
carriage  from  the  North.  This  difference  in  cost 
will  amount,  in  effect,  to  a  comparative  advantage 
in  production  and  hence  may  prevent  the  rise  in 
price  of  the  commodity  up  to  the  full  amount  of  the 
duty. 

Protection  of  Young  Industries  —  The  greatest 
strength  of  the  arguments  in  favor  of  the  retention 
or  development  of  the  protective  system  lies  in  the 
appeal  for  the  protection  of  young  industries.  But 
before  we  can  discuss  this  we  must  analyze  the  reasons 
upon  which  the  demand  is  based. 

In  the  first  place  it  may  be  claimed  that  there  is  a 


PROTECTION  AND  FREE   TRADE  293 

comparative  advantage  in  the  production  of  a  certain 
commodity,  when  the  manufacture  or  production  is 
at  maturity,  but  that  in  the  early  stages  of  production 
the  industry  could  not  compete  with  the  already  ma- 
tured foreign  competitor.  Hence  it  is  claimed  that 
if  this  industry  is  protected  in  its  early  growth  it  will 
have  a  chance  to  develop  into  a  strong  position  and 
ultimately  hold  its  own  on  even  terms  with  the  foreign 
industry,  and  even  to  defeat  such  competition  in 
foreign  markets. 

In  the  second  place,  it  may  be  admitted  at  the 
outset  that  the  question  of  comparative  advantage 
does  not  arise  at  all ;  that  the  industry  under  con- 
sideration does  not  and  cannot  possess  a  comparative 
advantage.  The  basis  of  the  argument  for  protection, 
however,  does  not  lie  so  much  in  economic  considera- 
tions as  in  political.  It  is  believed  that,  in  order  to 
be  prepared  for  emergencies,  such  as  war,  for  instance, 
a  country  should  be  as  nearly  as  possible  self-support- 
ing, and  particularly  so  in  the  case  of  production  of 
means  of  warfare.  It  is  obvious,  in  this  case,  that  the 
argument  based  on  the  possibility  or  otherwise  of 
producing  at  a  comparative  advantage  is  beside  the 
point.  The  main  idea  is  based  on  the  possibility  of 
production  at  all,  no  matter  at  what  cost. 

A  further  argument  affecting  the  question  of  pro- 
tecting industries  is  the  "  foreign  cheap  labor " 
argument.  It  is  claimed  that,'  as  the  average  rate 
of  wages  in  America  is  higher  than  in  the  older  coun- 
tries, the  industry  which  is  just  commencing  and 
even  the  mature  industry  is  at  a  disadvantage  in  that 
its  wages  cost  is  so  much  higher  than  abroad. 


294  AN   INTRODUCTION   TO   ECONOMICS 

These  three  arguments  are  the  chief  support  of  the 
protectionist  case  for  the  protection  of  industry.  We 
shall  now  consider  them  carefully  and  attempt  to  de- 
termine the  extent  of  their  validity. 

The  first  case  divides  itself  into  two  main  sections. 
First,  the  case  of  young  industries  commencing  in  a 
young  country,  and  second,  the  case  of  young  indus- 
tries in  a  country  already  well  established  in  pro- 
duction. The  first  case  is  well  illustrated  by  countries 
such  as  the  United  States  in  its  early  days,  and  by 
the  more  important  of  the  British  colonies. 

In  those  industries  in  which  the  initial  cost  of  estab- 
lishment is  small,  the  question  of  long  establishment 
is  not  important.  If  fixed  capital  bears  a  small  ratio 
to  the  total  capital  involved  and  if  the  labor  facilities 
are  ample,  there  is  no  reason  for  protection.  The 
industries  will  commence  at  the  outset  in  as  good 
a  position  as  those  of  established  foreign  countries. 
This  is  provided,  of  course,  that  the  comparative 
advantage  of  production,  if  any,  is  in  favor  of  the 
new  country.  Of  course,  the  case  is  different  if  the 
comparative  advantage  lies  with  the  old  country. 
But  in  this  case,  the  question  of  protection  comes 
under  the  discussion  of  our  second  main  heading,  and 
so  may  be  ignored  here. 

In  other  cases,  where  the  initial  cost  of  establish- 
ment is  heavy,  and  where  the  labor  skill  has  to  be 
gradually  acquired,  there  is  a  very  much  stronger 
case  for  protection.  In  the  establishment  of  any 
industry  which  requires  a  heavy  expenditure  for 
fixed  capital  there  is  usually  a  considerable  lapse  of 
time  before  returns  for  that  expenditure  are  received. 


PROTECTION  AND  FREE   TRADE  295 

This  is  true,  even  where  the  labor  skill  is  already  exist- 
ent and  available.  A  manufacturer  who  starts  such 
an  industry,  in  the  face  of  efficient  competition,  is 
at  a  disadvantage.  This  is  so,  even  if  he  has  not  to 
consider  competition  from  other  firms  who  are  already 
well  established. 

The  object  of  protection  is  to  eliminate  competition 
and  so  permit  the  manufacturer  to  commence  work 
with  only  the  ordinary  disadvantage  of  having  to 
wait  a  certain  time  for  returns  on  his  investment. 
Even  this  is  sometimes  made  more  easy  for  him  by 
the  offer  of  bounties  on  the  export  or  production  of 
the  new  goods.  This,  of  course,  is  merely  another 
form  of  protection.  It  is  assumed,  however,  by  the 
very  nature  of  the  claim  itself,  that  when  the  industry 
is  mature  and  well  established,  the  initial  difficulties 
will  be  overcome  —  the  infant  industry  will  have 
gained  its  majority  and  will  no  longer  require  pro- 
tection. Indeed  the  industry  ought  to  be  able  to 
produce  at  a  cheaper  rate  than  that  charged  for  the 
foreign  goods  and  thus  reimburse  the  country  for  the 
original  expenditure  in  protecting  its  young  growth. 

In  this  case  it  is  necessary  to  assume  that  the  indus- 
try only  requires  temporary  protection.  The  object 
of  the  protection  is  to  permit  the  industry  to  be  estab- 
lished on  a  sound  footing  and  then  let  it  take  its  own 
place  in  the  competitive  system.  The  question  then 
arises :  When  is  it  clear  that  the  industry  no  longer 
needs  the  protection?  In  other  words,  when  does  an 
industry  reach  maturity?  Herein  lies  the  objection 
urged  even  against  such  protection  as  we  have  outlined. 
Industries  which  orginally  demanded  protection  on 


296  AN  INTRODUCTION  TO   ECONOMICS 

account  of  their  infancy  insist  on  the  retention  of 
the  protective  duties  when  they  have  reached  a  lusty 
maturity.  When  it  is  clear  that  an  industry  can  obtain 
its  product  at  a  cost  as  low  as  that  of  foreign  countries 
and  can,  therefore,  compete  on  satisfactory  terms  with 
any  foreign  goods  that  may  be  imported,  it  has 
obviously  reached  maturity.  If  the  industry  goes  on 
from  decade  to  decade  and  still  the  cost  of  produc- 
tion is  greater  than  that  of  foreign  countries,  it  is 
clear  that  the  comparative  advantage  lies  with  the 
latter,  and  hence  the  justification  of  the  continuance 
of  protective  duties  lies  outside  the  consideration  of 
our  present  argument.  It  is  not  sufficient  that  the 
industry  should  show  merely  a  reduction  in  the  cost 
of  production  and  a  consequent  reduction  in  price 
to  consumers.  For  it  may  be  that  a  similar  reduction 
can  be  shown  in  regard  to  foreign-produced  goods. 
The  reduction  must  eventually  be  down  to  that  of 
the  foreign  goods.  If  this  equality  in  cost  of  produc- 
tion is  never  reached,  then  the  continuance  of  pro- 
tection constitutes  a  tax  on  the  consumers  which 
may  or  may  not  be  justified  by  other  considerations. 
At  any  rate  it  no  longer  rests  upon  the  necessity  of 
protecting  a  young  industry. 

Even  admitting  the  validity  of  the  argument,  there- 
fore, the  difficulty  of  ceasing  to  protect  an  industry 
when  it  has  reached  maturity  constitutes  an  argument 
against  such  protection.  It  must  be  understood,  of 
course,  that  a  sudden  cessation  of  protection  may  be 
extremely  unwise,  but  even  the  ardent  free-trader 
seldom  demands  that  an  industry  which  has  been 
protected  for  many  years  should,  at  a  single  stroke, 


PROTECTION  AND  FREE   TRADE  297 

be  deprived  of  all  protection.  But  in  actual  practice, 
every  suggestion  for  a  diminution  of  the  duties  is 
bitterly  fought,  the  grounds  in  favor  of  the  retention 
of  the  duties  being  changed  to  suit  the  new  circum- 
stances. Even  in  the  same  breath  that  the  manu- 
facturer boasts  of  the  superiority  of  his  goods  to  those 
of  the  foreigner,  he  declares  that,  without  protection, 
his  industry  must  fail. 

From  being  asked  as  an  encouragement  to  commence 
a  new  industry,  protection  comes  to  be  demanded  as 
a  right,  and  is  regarded  as  a  permanent  institution. 
It  is  because  of  this  tendency  for  the  protection  to 
be  afforded  long  after  the  original  necessity  has  ceased, 
that  the  free-trader  regards  even  "  young  industry  " 
protection  as  poor  policy. 

The  same  arguments  apply  equally  to  protection  of 
new  industries  in  a  country  already  well  established. 
But  in  addition  it  may  be  said  that  the  more  one 
admits  of  protection  to  new  industries  in  such  a  country 
the  more  one  arouses  a  general  demand  for  protection 
on  the  part  of  other  industries.  Industries  may  be 
new,  but  it  does  not  necessarily  follow  that  their 
establishment  is  a  matter  of  difficulty  on  account  of 
existing  foreign  competition.  If  the  new  industries 
are  simply  further  developments  of  existing  industries, 
there  is  hardly  a  case  for  protection  on  the  grounds 
of  newness.  If,  on  the  other  hand,  they  are  not  con- 
nected with  any  existing  industry  and  have  to  be 
built  up  from  the  ground,  their  case  comes  under  the 
same  general  arguments  as  those  which  support  pro- 
tection to  infant  industries  in  a  new  country. 

On  the  whole,  we  may  sum  up  the  argument  in  favor 


298  AN  INTRODUCTION  TO  ECONOMICS 

of  protecting  infant  industries  by  admitting  that 
there  is  a  great  justification  for  protection,  but  that 
a  considerable  difficulty  is  caused  later  by  the  fact 
that  it  is  next  to  impossible  to  persuade  those  in  con- 
trol of  an  industry  that  the  period  of  infancy  has 
passed,  and  a  further  difficulty  is  the  creation  of  a 
feeling  that  protection  is  a  natural  state  of  industry. 
It  is  noticeable  that  when  industries  cease  to  be  infants, 
those  in  control  demand  the  continuance  and  even 
the  increase  of  protection  on  quite  different  grounds, 
and  we  shall  now,  therefore,  proceed  to  the  discussion 
of  some  of  those  additional  arguments. 

The  National  System  —  The  discussion  of  this 
second  basis  of  protectionist  arguments  really  belongs 
to  the  field  of  political  science.  If  we  assume  that 
the  true  purpose  of  economics  is  to  show  under  what 
conditions  the  world  may  make  the  best  use  of  its 
economic  possibilities,  we  are  inevitably  led  to  the 
conclusion  that  the  doctrine  of  comparative  advantage, 
or,  as  we  have  previously  called  it,  the  law  of  compara- 
tive cost,  must  have  the  freest  possible  play.  The 
law  of  comparative  cost  is  only  the  application  of 
the  principle  of  division  of  labor  on  a  wide  scale, 
a  division  according  to  territories  instead  of  accord- 
ing to  individuals.  Anything  which  hinders  this 
free  play  is,  therefore,  a  hindrance  to  the  fullest  eco- 
nomic development,  and  consequently  a  protective 
system,  which  is  designed  as  a  hindrance  to  such  free 
play,  helps  to  prevent  that  full  economic  develop- 
ment. 

The  free  economic  development  of  the  world,  how- 
ever, takes  no  regard  of  national  aims.  It  is  dis- 


PROTECTION  AND  FREE   TRADE  299 

tinctly  international  in  its  character.  National  aims 
presuppose  the  possibility  and  indeed  the  probability 
of  mutual  antagonism  between  nations.  Hence  it 
is  not  considered  an  unmixed  blessing  that  the  whole 
of  the  world's  development  should  be  in  strict  accord 
with  its  economic  possibilities.  Each  nation,  accord- 
ing to  the  supporters  of  the  national  point  of  view, 
must  regard  itself  as  complete,  a  separate  and  well- 
defined  entity.  Within  the  nation  the  greatest  possible 
economic  development  may  take  place.  But  that  a 
nation  should  be  dependent  upon  another  for  any 
commodity  or  service  which  it  could  provide  itself, 
would  be  a  reduction  of  the  national  strength. 

The  strongest  case  is  made  out  in  times  of  war. 
At  such  a  time  it  may  be  essential  that  each  country 
should  be  as  self-supporting  as  possible.  The  more 
a  country  approaches  to  the  state  of  a  complete  eco- 
nomic unit,  the  less  the  danger  of  its  being  starved 
through  a  blockade,  or  forced  to  surrender  through  a 
lack  of  means  to  produce  munitions  of  war. 

Granting  the  importance  of  securing  this  economic 
unity,  how  does  the  protective  principle  affect  the 
solution  of  the  difficulty?  Purely  by  preventing 
the  operation  of  the  law  of  comparative  costs.  If  the 
desires  of  a  people  remain  constant,  the  prevention 
of  the  satisfaction  of  these  desires  through  foreign 
commerce  leads  to  the  demand  for  domestic  production, 
and  hence  industries  which,  in  a  state  of  free  compe- 
tition with  foreign  countries  would  not  stand  a  chance 
of  existence,  are  brought  into  being  and  may  flourish. 

Obviously  this  is  not  done  without  a  loss  to  the 
community.  Whether  the  loss  is  commensurate  with 


300  AN  INTRODUCTION   TO   ECONOMICS 

the  gain  secured  by  reason  of  the  attempted  economic 
independence  in  time  of  war,  is  indefinite.  Granted 
that  a  war  takes  place,  it  does  not  necessarily  follow 
that  the  countries  involved  will  be  compelled  to  depend 
upon  internal  resources  for  all  economic  needs.  A  first- 
class  war,  in  these  days,  seldom  confines  itself  to  two 
nations.  The  late  war  is  an  illustration  of  the  position. 
It  is  extremely  doubtful  whether  the  war  would  have 
been  more  satisfactorily  conducted,  from  the  point 
of  view  of  either  side,  had  the  countries  concerned 
been  individually  economic  units,  or  had  they  even 
approached  this  state. 

On  the  other  hand,  in  order  to  secure  this  problem- 
atical advantage  in  the  case  of  war,  the  community 
is  undoubtedly  saddled  with  a  very  considerable 
addition  to  the  cost  of  its  necessities,  which  means  a 
corresponding  decrease  in  the  possibilities  of  internal 
development. 

The  foregoing  argument  is  based  on  the  assumption 
that  a  protective  system  would  be  successful  in  securing 
a  comparative  economic  unity.  It  is  not  possible, 
however,  for  any  system  to  do  more  than  limit  a 
country's  dependence  upon  external  supplies.  Many 
of  the  necessities  of  our  present  life  are  capable  of 
being  produced  only  in  limited  areas  of  the  world's 
surface,  and  as  these  products  must  be  paid  for  by 
the  exchange  of  goods  a  certain  amount  of  interna- 
tional trade  is  essential. 

From  the  point  of  view  of  the  nationalist  argument, 
therefore,  the  protectionist  method  results  in  the 
payment  of  a  very  heavy  price,  increasing  with  the 
success  of  the  method,  for  a  problematical  advantage. 


PROTECTION  AND  FREE  TRADE  301 

The  Mercantilist  Argument  —  We  now  turn  to 
another  protectionist  argument  which  has  enjoyed 
a  great  deal  of  support  from  protectionists  of  earlier 
days  and,  indeed,  through  some  of  its  terminology, 
remains  popular  to  the  present  time.  The  school  of 
economists  who  preceded  Adam  Smith  in  the  middle 
of  the  eighteenth  century  were  known  as  mercan- 
tilists. It  is  not  necessary  to  discuss  the  whole  body 
of  their  economic  doctrines,  but  we  must  take  notice 
of  the  chief,  or  one  of  the  chief  ideas  that  they  pro- 
mulgated. The  mercantilists  laid  stress  on  money 
as  an  indication  of  national  wealth.  They  were 
inclined  to  believe  that  the  wealth  of  a  country  varied 
directly  with  the  amount  of  gold  and  silver  that  it 
possessed.  Hence  they  urged  that  such  measures 
should  be  adopted  by  government,  in  its  regulations 
of  commerce,  as  would  secure  the  greatest  influx  of 
the  precious  metals  into  the  country,  and  at  the  same 
time  prevent  their  export. 

They  argued  that  if  the  amount  of  exported  mer- 
chandise exceed  the  value  of  the  imported,  the  dif- 
ference must  be  paid  in  coin,  and  hence  the  excess  of 
exports  over  imports  necessarily  resulted  in  an  influx 
of  gold  to  pay  for  the  difference.  This  difference 
they  spoke  of  as  the  "  balance  of  trade."  When 
exports  exceeded  imports  the  balance  was  said  to 
be  in  favor  of  the  exporting  country,  and  vice  versa. 
We  still  hear  these  terms  used  in  discussion  of  tariff 
problems  and  indeed  other  economic  problems,  but 
we  already  know  from  our  discussion  of  the  principles 
of  international  trade,  that  the  term  balance  of  trade, 
as  used  by  the  mercantilists,  was  meaningless. 


302  AN   INTRODUCTION   TO   ECONOMICS 

Where  these  thinkers  were  at  fault  was  in  their 
consideration  of  visible  exports  and  imports  alone. 
They  were  not  aware  of  the  now  well-recognized  fact 
that  the  invisible  exports  and  imports  account  for  a 
great  deal,  if  not  all  of  the  so-called  balance.  Even 
if  we  suppose  it  to  be  true  that  the  best  index  to  a 
country's  wealth  consists  in  the  amount  of  gold  within 
the  country,  the  actual  facts  do  not  show  that  an 
excess  of  visible  exports  over  visible  imports  leads 
to  an  influx  of  gold.  As  we  have  already  seen,  the 
movements  of  gold  are  controlled  by  totally  different 
factors. 

But  it  is  surely  obvious  that  the  possession  of  gold 
is  not  an  indication  of  national  wealth.  The  point 
is  so  trite  that  it  is  not  worth  considering.  Indeed 
it  is  surprising  that  the  mercantilists  themselves  did 
not  realize  the  full  extent  of  their  fallacy  with  the 
amount  of  historical  refutation  available  to  them. 
At  any  rate,  such  a  belief  is  inexcusable  nowadays. 

Cheap  Labor  —  Another  argument  which  is  fre- 
quently used  in  support  of  the  continuance  of  pro- 
tection is  what  is  known  as  the  "  cheap  labor  "  ar- 
gument. It  is  pointed  out  that  American  labor  is 
comparatively  highly  paid  and  hence  the  labor  cost 
of  the  American  product  is  high  in  proportion.  The 
American  manufacturer  is,  therefore,  handicapped  in 
competing  with  the  foreigner  who  uses  cheap  labor. 
It  is  made  a  strong  point  that  the  protection  is  required 
not  so  much  for  the  manufacturer  as  for  the  workmen 
themselves. 

Investigation  of  this  argument,  however,  shows  that 
it  is  not  so  strong  as  appears  at  first  sight.  In  the 


PROTECTION  AND  FREE  TRADE       303 

first  place  there  is  a  distinct  fallacy  in  the  statement 
that  high  wages  mean  high  labor  cost.  This  by  no 
means  follows  ;  in  fact,  it  is  usually  the  reverse.  High 
wages  are  apt  to  coincide  with  a  high  degree  of  machine 
work  and  efficiency  and  as  a  consequence,  it  often 
follows  that  high  wages  lead  to  reduced  labor  cost. 
If  this  is  the  case,  and  it  is  demonstrably  true  in  a 
great  many  instances,  the  argument  that  protection 
is  required  to  prevent  the  evils  of  competition  from 
cheap  labor,  falls  to  the  ground.  The  inefficiency 
of  cheap  labor  is  notorious,  or  should  be  to  any  one 
who  has  spent  a  short  time  in  studying  the  working 
cost  of  Asiatic  productions  and  the  labor  cost  of  cheap 
labor  products  in  Europe.  The  yellow  peril  need 
not  cause  much  fear  if  the  true  facts  of  labor  cost  are 
understood. 

Dumping  —  One  final  argument  we  shall  notice. 
It  is  claimed  that  a  country  should  protect  its  producers 
from  the  competition  of  "  dumped  "  foreign  goods. 
What  is  meant  by  dumping?  Cheap  production 
may  often  best  be  secured  through  large-scale  opera- 
tions, but  the  highest  returns  may  be  obtained  by  a 
comparatively  small  home  sale  at  a  relatively  high 
price.  If  this  idea  is  followed  out  a  manufacturer 
may  sell  part  of  his  product  in  the  home  market, 
carefully  restricting  the  supply  available  for  that 
market  in  order  to  reap  the  high  price.  What  is 
left  of  his  stock  he  can  afford  to  dispose  of  at  a  reduced 
price  in  some  other  market.  Hence  he  sells  the 
remainder  to  a  foreign  buyer  at  a  low  price,  possibly 
covering  cost,  possibly  even  at  a  loss,  for  anything 
received  for  this  amount  which  he  definitely  with- 


304  AN   INTRODUCTION    TO   ECONOMICS 

holds  from  the  home  market  is  so  much  profit.  This 
cheap  disposal  to  a  foreign  country  is  known  as  "dump- 
ing." A  careful  study  of  the  process,  however,  will 
show  that  dumping  is  only  possible  under  certain 
conditions.  The  product  must  be  in  the  nature  of 
a  monopoly ;  otherwise  the  market  could  not  be  held 
up  to  the  high  price  at  home.  Even  then  the  production 
must  be  operated  under  the  law  of  increasing  returns. 
For  if  this  is  not  the  case  there  will  be  no  profit  in 
producing  the  extra  quantity  of  goods  which  are 
dumped.  This  extra  amount  would  increase  the 
relative  cost,  or  cost  per  unit,  and  therefore  reduce 
the  home  profits  instead  of  adding  to  them. 

Dumping  at  a  price  less  than  cost,  or  even  at  cost, 
is  only  possible  for  a  certain  length  of  time.  The 
prevailing  high  prices  in  the  home  country,  which 
provide  the  means  of  sustaining  the  dumping  process, 
are  sure,  sooner  or  later,  to  arouse  competition.  This 
will  reduce  prices  and  so  prevent  the  continuance  of 
dumping  without  the  serious  risk  of  bankruptcy.  As 
a  temporary  expedient  many  firms  who  have  tried  it 
have  found  dumping  to  be  unsatisfactory.1 

In  this  discussion  of  the  protectionist  and  free  trade 
doctrines  we  have  carefully  refrained  from  the  use  of 
statistics.  There  is  no  greater  danger  to  the  satis- 
factory discussion  of  economic  problems  than  the 
use  of  statistics  by  those  who  are  untrained.  It  has 

1  This  spasmodic  dumping  has  been  criticized  as  causing  irregular  work, 
tending  to  spoil  reputation  because  quality  and  costs  are  cut  keenly.  The 
president  of  the  United  States  Steel  Corporation  spoke  of  this  sort  of 
dumping  as  a  kind  that  "does  not  develop  continuous  business."  (Testi- 
mony of  the  government  suit  against  the  Steel  Corporation.  1913,  x,  p.  3843.) 


PROTECTION   AND  FREE   TRADE  305 

been  said  that  figures  will  prove  anything.  If  the 
principles  of  statistical  science  are  followed  out  this 
statement  is  not  true,  but  an  unscientific  use  of  statistics 
will  often  bolster  up  an  argument  which  is  really 
untenable. 


CHAPTER  XXIII 

INVESTMENT   AND    SPECULATION 

The  Flow  of  Capital  —  We  have  already  had  occa- 
sion to  refer  to  the  flow  of  capital.  This  must  now 
be  considered  a  little  more  fully.  Our  definition  of 
the  term  included  "  that  form  of  wealth  which  is 
used  for  the  production  of  more  wealth."  This 
definition  is  unaffected  by  the  ownership  of  the  capital. 
The  owner  of  wealth  who  desires  to  use  it  for  the  pro- 
duction of  more  wealth  does  not  necessarily  have  to 
employ  the  capital  himself.  He  may  lend  it,  for  a 
consideration,  to  others  who  will  use  it  in  their  business. 
The  transfer  of  the  capital  from  the  owner  to  the 
user  does  not  alter  its  character. 

We  may  take  it  as  a  fundamental  fact  that,  other 
things  being  equal,  the  owner  of  the  capital  desires 
to  obtain  the  greatest  return  possible  from  its  use. 
The  limitation  is  important,  for  the  element  of  the 
safety  of  the  capital  is  one  which  deserves  careful 
consideration.  Of  two  methods  of  using  capital, 
both  of  which  are  equally  safe,  that  one  will  be  chosen 
which  promises  the  greater  return.  Hence  capital 
which  is  employed  in  a  business  which  does  not  lend 
itself  to  the  earning  of  the  largest  returns  consistent 
with  safety  is  always  liable  to  be  transferred  to  another 
industry  or  occupation  where  the  profits  are  higher. 
This  is  only  true,  however,  of  liquid  capital.  Fixed 
306 


INVESTMENT   AND    SPECULATION  307 

capital  cannot  be  easily  transferred.  It  is  not  true, 
for  instance,  that  because  the  automobile  industry 
promises  greater  returns  to  capital  than  the  cotton 
industry,  cotton  factories  will  therefore  be  turned 
into  automobile  plants.  On  the  other  hand,  a  firm 
which  has  been  engaged  in  manufacturing  bicycles 
may  realize  that  greater  profits  could  be  obtained 
by  making  motor  cycles  and  may  comparatively  easily 
adapt  its  machinery  to  such  production.  This  is 
possible  only  where  the  fixed  capital  employed  in  the 
old  business  is  capable  of  being  used  in  the  manufacture 
of  the  new  product  with  comparatively  little  change. 
How  then  does  capital  flow  from  one  industry  to 
another  ? 

Investment  —  There  is  always  a  certain  amount  of 
what  is  known  as  liquid  capital  seeking  employment. 
This  capital  is  always  represented  by  money  or  the 
equivalent  of  money.  That  is  to  say,  it  is  not  fixed 
capital.  It  may  be  converted  into  fixed  capital,  of 
course,  for  money  and  its  equivalents  imply  a  com- 
mand of  fixed  capital.  This  money  is  open  for  invest- 
ment. That  is  to  say,  the  owners  are  not,  as  a  rule, 
desirous  of  using  the  capital  themselves.  They  are 
willing  that  others  should  use  it,  provided  they  receive 
a  share  in  the  profits  resultant  from  its  use. 

Merchants  and  manufacturers  who  do  not  themselves 
possess  sufficient  capital  for  their  own  requirements, 
and  who  could  use  more  with  satisfactory  results, 
invite  the  owners  of  idle  capital  to  lend  them  their 
funds,  or  to  "  invest  them  in  the  business."  The 
investors  do  not  necessarily  lose  control  of  their  capital. 
In  most  cases  the  fact  that  they  have  invested  funds 


308  AN  INTRODUCTION   TO   ECONOMICS 

in  a  business  gives  them  the  right  to  a  say  in  the  man- 
agement of  the  business,  proportionately  to  the  amount 
invested.  Apart  from  this  fact,  however,  they  are 
always  at  liberty  to  sell  their  holdings  to  others,  if 
they  can  find  purchasers.  In  this  way  the  fixed 
capital  remains  with  the  business.  All  that  changes 
is  the  ownership. 

The  profits  resulting  from  the  employment  of  capital 
may  be  used  in  two  ways.  Either  they  may  be  used 
for  the  purchase  of  consumption  goods;  that  is,  goods 
to  be  used  in  the  satisfaction  of  ultimate  wants,  or 
they  may  be  invested  in  business.  With  the  former 
use  we  are  not  at  present  concerned.  The  latter, 
however,  is  the  method  by  which  the  flow  of  capital 
is  secured. 

As  we  have  said,  capital  flows  toward  those  occupa- 
tions which  provide  the  greatest  returns,  other  things 
being  equal.  There  is  always  a  point  at  which  capital 
will  cease  to  be  employed  in  any  business.  That 
is  the  point  at  which  the  profits  are  not  sufficient  to 
provide  more  than  the  necessary  expenses  of  opera- 
tion. This  statement,  in  practice,  requires  a  cer- 
tain modification.  Investors  do  not  always  look  to 
immediate  results.  It  is  quite  possible  for  capital 
to  be  attracted  toward  an  industry  or  business  which 
at  the  moment  is  not  earning  profits.  In  these  cases, 
however,  the  investors  hope  that  the  future  profits 
will  be  such  as  to  offset  the  temporary  lack  of  earnings. 

But  in  the  ordinary  case  where  a  business  has  ceased 
to  earn  profits  in  excess  of  the  operating  expense, 
those  who  have  invested  their  funds  in  the  business 
will  endeavor  to  sell  their  holdings  even  at  a  loss, 


INVESTMENT  AND   SPECULATION  309 

in  order  that  they  may  invest  the  proceeds  in  some 
business  that  is  actually  earning  profits.  They  realize 
that  it  is  better  to  earn  a  profit  on  a  small  investment 
than  nothing  on  a  large  one.  The  buyer  of  the  shares 
justifies  himself  with  the  belief  either  that  the  business 
is  likely  to  improve,  or  that  in  liquidation  he  will 
receive  a  sum  greater  than  that  paid  for  the  shares. 
Usually  it  is  the  former  which  decides  the  purchase. 
Occasionally,  also,  the  holder  of  an  investment  desires 
to  use  his  funds  for  the  purchase  of  consumers'  goods, 
in  which  case,  all  that  happens  is  that  the  ownership 
of  the  investment  changes  hands. 

Par  and  Investment  Price  —  In  the  buying  and 
selling  of  invested  capital  there  is  a  great  deal  of  price 
fluctuation.  Leaving  out  of  consideration,  for  the 
present,  fluctuations  due  to  speculative  causes,  the 
changes  in  price  are  primarily  due  to  changes  in 
the  earning  power  of  the  business.  Following  out  the 
laws  of  supply  and  demand,  which  we  have  already 
studied,  there  is  a  tendency  for  the  returns  to  the 
investment  to  be  averaged  fairly  evenly.  Given 
equality  of  security,  for  instance,  we  may  say  with  a 
fair  degree  of  accuracy,  that  the  returns  to  one  invest- 
ment will  tend  to  equal  those  from  another  of  the  same 
amount.  To  illustrate  this,  let  us  suppose  that  by 
investing  $1000  in  a  certain  business  a  return  of  4 
per  cent  is  secured.  Let  us  suppose  that  the  average 
rate  of  interest  is  5  per  cent.  No  person  who  buys 
the  investment  of  $1000  from  the  original  investor 
will  give  $1000  in  payment.  His  reasoning  is  simple. 
By  investing  $1000  at  the  average  rate  he  can  obtain 
5  per  cent.  Why,  therefore,  should  he  pay  for  an 


310  AN  INTRODUCTION   TO   ECONOMICS 

investment  which  will  only  yield  4  per  cent?  He 
offers,  let  us  say,  $800.  If  the  sale  is  made,  then  the 
new  holder  of  the  investment  receives  as  interest  on 
his  shares  4  per  cent  on  the  original  $1000,  or  $40.  But 
as  he  only  paid  $800  for  the  investment,  the  actual 
amount  earned  on  that  $800  is  equal  to  a  rate  of  5 
per  cent,  the  average  rate. 

If,  on  the  other  hand,  the  average  rate  of  interest  is 
3  per  cent,  the  holder  of  the  original  $1000  shares 
will  not  sell  at  par,  or  face  value.  If  he  did,  and  then 
tried  to  invest  the  $1000  again,  he  would  only  gain 
3  per  cent  instead  of  four.  He  demands  a  higher 
price  and  the  sale  is  made  at  about  $1300,  which 
gives  a  rate  of  approximately  3  per  cent  to  the  pur- 
chaser. When  shares  are  sold  at  their  face  value, 
they  are  said  to  be  at  par;  when  sold  at  less  than 
par  value,  they  are  sold  at  a  discount,  and  when  sold 
at  more  than  par,  they  are  at  a  premium.  Shares, 
therefore,  tend  to  be  at  a  premium  when  the  rate 
earned  is  greater  than  the  average  rate  and  at  a  dis- 
count when  it  is  less  than  the  average  rate. 

The  Future  Element  in  Business  —  This  is  simple 
enough  to  understand  if  we  consider  the  price  as  being 
entirely  determined  by  the  present  earning  capacity  of 
the  business.  But  the  investment  market  is  very 
easily  influenced  by  hopes  and  fears.  In  fact  it  would 
be  almost  safe  to  say  that  the  hopes  and  fears  have  a 
greater  influence  on  the  market  than  present  conditions. 
Now  the  causes  which  produce  and  influence  these 
hopes  and  fears  are  innumerable.  Hence  there  is  a 
constant  fluctuation  in  the  value  of  investments. 

The  future  element  in  business  is  not  confined  to 


INVESTMENT  AND   SPECULATION  311 

stock  and  share  investments,  however.  In  every 
aspect  of  business  the  future  is  to  a  certain  extent 
discounted.  The  prices  of  commodities  are  affected  by 
the  prospects  of  increase  or  decrease  in  the  supply,  a 
possible  scarcity  in  the  future  leading  to  a  holding  of 
stocks  for  the  future  market,  thus  raising  prices  in 
the  present  market  by  reducing  the  effective  supply, 
and  reducing  future  prices  by  increasing  the  future 
supply. 

Speculation  —  It  is  the  future  element  in  business 
which  gives  rise  to  speculation.  There  is  hardly  any 
more  controversial  subject  than  the  question  of  the 
values  and  evils  of  speculation.  In  order  that  we  may 
examine  this  question  in  a  satisfactory  manner  we 
must  be  quite  clear  as  to  the  meaning  of  the  term. 
Like  many  others,  it  is  used  with  great  laxity  of  mean- 
ing, and  without  careful  definition  no  argument  is 
possible. 

In  every  meaning  which  is  attached  to  the  term 
speculation,  there  is  one  common  element,  that  of 
future  uncertainty.  The  greater  this  uncertainty, 
the  greater  is  the  speculative  element.  But  future 
uncertainty  is  ever  present  in  life,  and  business  is 
peculiarly  subject  to  it.  Any  man  who  undertakes 
to  supply  some  of  the  needs  of  the  community  runs 
the  risk  of  misjudging  those  needs,  or  of  not  being 
able  to  satisfy  them  at  a  price  remunerative  to  him- 
self. He  runs  the  risk  of  being  forced  out  of  business 
by  competition,  by  inability  to  do  the  work  properly, 
by  lack  of  capital,  by  failure  in  the  supply  of  raw  ma- 
terials, by  convulsions  of  nature  which  destroy  the 
economic  value  of  his  situation,  by  the  vagaries  of  the 


312  AN  INTRODUCTION   TO   ECONOMICS 

weather,  and  so  on  to  infinity.  Any  man  who  wishes  to 
enter  business  and  avoid  these  risks  is  asking  the 
impossible.  In  so  far  as  he  accepts  these  risks  he  is 
speculating.  That  is,  he  is  taking  a  chance  that  his 
future  profits  will  not  be  seriously  interfered  with 
by  these  possible  future  dangers. 

No  one  will  attempt  to  deny  that  this  sort  of  specu- 
lation, the  risking  of  the  inevitable  dangers  of  com- 
mercial life,  is  justifiable.  It  has  its  evils,  no  doubt, 
but  these  evils  are  inherent  in  commercial  life  and 
cannot  be  avoided.  No  one  has  any  respect  for  him 
who  wraps  his  talent  in  a  napkin  and  buries  it. 

But  these  inevitable  risks  are  minimized  to  the 
greatest  possible  extent  by  the  wise  business  man. 
A  good  farmer  does  not  plant  his  seed  without  consid- 
ering first  the  possibility  of  getting  the  crops  to  market. 
The  banker  does  not  invest  the  capital  of  a  metro- 
politan bank  in  a  little  country  town.  Still,  no  matter 
how  great  the  care  taken,  losses  are  bound  to  occur. 
All  that  can  be  done  is  to  minimize  the  losses  and 
spread  them  over  as  large  an  area  as  possible  so  that 
the  blow  to  the  individual  will  be  lightened. 

In  many  discussions  of  speculation  great  stress  is 
laid  upon  the  form  which  we  have  just  described. 
But  the  discussions  lack  life,  for  the  common  use  of 
the  term  practically  ignores  that  form  of  its  application. 

Stock  and  Share  Investment  —  We  have  already 
seen  that  in  the  sale  and  purchase  of  stocks  and  bonds 
we  have  the  mechanism  for  the  flow  of  capital.  Assum- 
ing the  existence  of  the  free  play  of  competition  in  an 
open  market,  the  rate  of  profit  on  industry  is  determined 
by  the  ability  displayed  by  the  manufacturer  or  mer- 


INVESTMENT   AND   SPECULATION  313 

chant  in  satisfying  the  demands  of  the  community, 
or  by  special  circumstances  which  give  him  a  peculiar 
advantage  in  producing  the  goods  or  services  required. 
Loss  occurs  when  the  demand  of  the  community 
does  not  exist  or  is  not  of  sufficient  strength  to  justify 
the  amount  produced.  Hence  the  flow  of  capital 
tends  to  insure  that  those  services  which  are  desired 
by  the  community  attract  the  necessary  amount  of 
capital  to  cause  their  production. 

The  owner  of  capital  which  is  free  for  investment 
must  keep  a  keen  watch  upon  the  growing  needs  of 
the  community.  If  his  judgment  shows  him  that  a 
particular  commodity  or  service  is  likely  in  the  future 
to  be  in  greater  demand  by  the  community,  he  takes 
prompt  advantage  of  that  judgment  to  invest  his 
capital  in  the  production  of  that  commodity  or  service 
so  that  he  may  reap  the  profit  bound  to  be  realized 
as  the  public  demand  grows.  He  may  be  said  to 
render  a  public  service  in  that  he  anticipates  the  need 
of  the  community  and  provides  satisfactions  for  its 
desires  as  soon  as  they  arise. 

It  may  be,  of  course,  that  his  judgment  is  in  error, 
and  he  reaps  the  fruits  of  that  error  by  unnecessarily 
increasing  a  supply  and  consequently  decreasing  the 
price  of  some  commodity.  The  result  is  a  loss,  not 
only  to  him  but  to  other  producers  who  were  first 
in  the  market.  If  we  assume  that,  on  the  whole,  he 
is'  correct  in  his  anticipations,  then  he  prevents  the 
sudden  rise  in  prices  consequent  upon  a  sudden  increase 
in  demand  with  a  constant  or  decreasing  supply. 

To  make  this  more  clear,  let  us  take  an  illustration. 
Let  us  suppose  that  a  certain  investor  foresees  that, 


314  AN   INTRODUCTION   TO   ECONOMICS 

owing  to  the  discovery  of  some  new  method  of  pro- 
viding the  generating  force  for  electricity  there  is 
likely  to  be  a  great  increase  in  its  use.  The  result 
will  be  a  considerable  increase  in  the  demand  for 
copper,  rubber,  etc.,  for  conductors  and  insulators. 
He  invests  his  capital  in  the  production  of  copper 
and  to  that  extent  increases  the  supply  of  copper. 
As  the  demand  for  copper  materializes  the  supply 
is  shown  to  be  more  nearly  adequate  to  the  demand 
than  would  otherwise  have  been  the  case,  and  while 
there  may  still  be  an  increase  in  price,  the  increase 
is  not  so  great  as  it  would  have  been  had  there  been 
no  increase  in  the  supply.  The  public  is,  therefore, 
able  to  reap  the  benefit  from  increased  use  of  electric- 
ity without  having  to  pay  an  unduly  high  price  for 
copper. 

The  cases  referred  to  above,  however,  only  refer 
to  speculative  investments  and  not  to  pure  speculation. 
If  all  speculations  were  carried  on  with  the  idea  of 
reaping  profits  through  the  intelligent  anticipation 
of  the  future  needs  of  the  public,  there  would  be  little 
criticism.  Moreover,  there  would  be  no  desire  to 
juggle  with  the  prices  of  stocks  and  bonds.  But  a 
vast  amount  of  speculation  has  no  real  relation  to 
the  investment  of  capital.  The  speculators  do  not 
invest;  they  merely  play  with  the  rises  and  falls  in 
prices  of  different  securities.  This  amounts  to  mere 
gambling  and  in  spite  of  a  certain  amount  of  specious 
arguing  to  the  contrary,  there  can  be  no  economic 
justification  of  these  operations. 

The  Method  of  Stock  Exchange  Speculation  —  In 
order  to  understand  this  matter  better,  let  us  consider 


INVESTMENT  AND   SPECULATION  315 

the  methods  of  the  stock  exchange  speculator.  Sup- 
pose he  has  a  capital  of  $20,000  with  which  to  operate. 
He  decides  that  a  certain  stock,  let  us  say,  Montana 
Copper,  is  due  to  rise  in  price.  His  reasons  for  think- 
ing this  copper  company's  stock  will  go  up  may  be 
due  to  careful  consideration  of  the  copper  market, 
or  they  may  be  due  to  "  inside  information  "  that  a 
bigger  than  usual  dividend  is  to  be  declared;  or  he 
may  hear  that  some  big  operator  is  planning  to  get 
a  controlling  interest  in  the  mine,  or  any  other  of  a 
multitude  of  reasons.  Whatever  they  are,  however, 
he  decides  to  buy.  He  places  an  order  with  his  broker 
to  buy  a  thousand  shares  at  the  market  price  which 
is,  let  us  suppose,  110.  This  would  appear  to  call 
for  a  capital  of  at  least  $110,000,  which  is  more  than 
he  possesses.  He  does  not  pay  for  the  stock  himself, 
however,  he  merely  "  puts  up  a  margin  "  of  ten  points. 
That  is  he  pays  about  ten  per  cent  of  the  price  to  his 
broker.  The  broker  on  the  strength  of  the  deposit 
of  securities  with  the  bank  obtains  a  call  loan  for  the 
balance.  The  actual  amount  which  the  speculator 
has  paid  the  broker  is  $11,000.  Now  if  the  shares 
go  up  in  price  to  120  and  at  that  figure  the  speculator 
thinks  they  will  stay,  he  sells  out.  The  broker,  there- 
fore, pays  to  him  the  difference  between  the  price  at 
which  he  bought  and  the  price  at  which  he  sold  the 
shares,  together  with  his  margin,  deducting  the  usual 
commissions. 

Our  speculator,  therefore,  has  received  from  the 
broker  approximately  $22,000,  making  a  profit  of  over 
$10,000.  If  the  stock  had  gone  down  instead  of  up, 
the  broker  would  have  asked  the  speculator  to  support 


316  AN  INTRODUCTION   TO   ECONOMICS 

his  margins.  The  broker  requires  a  ten-point  margin. 
As  the  stock  goes  down  in  price  the  broker  knows 
that  he  will  receive  less  than  he  paid  for  it  if  he  sells. 
As  long  as  the  difference  between  the  purchase  and 
selling  prices  is  less  than  the  amount  deposited  by 
the  speculator  the  broker  is  safe,  for  by  selling  the 
stock  he  gets  the  bulk  of  the  price  back  and  the  dif- 
ference he  makes  good  by  drawing  on  the  deposited 
margin.  If  the  stock  falls  ten  points  instead  of  rising, 
the  speculator  may  still  keep  the  stock  by  paying 
additional  amounts  to  the  broker.  The  further  it 
falls,  however,  the  more  he  has  to  pay  in  and  there 
comes  a  time  when  he  can  pay  no  more.  The  broker 
sells  the  stock  "  at  the  market  "  and  the  difference 
is  made  good  out  of  the  speculator's  margins. 

It  will  be  noticed  that  this  speculation  has  not 
helped  the  industry  in  the  slightest.  In  fact  there 
has  been  no  investment  at  all  by  the  speculator.  He 
has  never  actually  held  the  stock  at  all.  The  stock 
has  really  been  held  by  the  bank  which  made  the 
call  loan.  The  speculator  has  merely  made  a  bet 
that  the  stock  would  rise.  If  he  wins  the  bet,  he 
profits.  If  he  loses,  some  one  else  profits.  In  any 
case  it  is  practically  certain  that  he  never  sees  the 
stock  he  is  dealing  in. 

The  case  is  still  clearer  when  the  speculator  is  sell- 
ing "  short."  He  may  believe  that  a  certain  stock, 
of  which  he  has  none,  is  likely  to  fall.  He  orders  his 
broker  to  sell  that  stock,  and  relies  upon  being  able 
to  buy  stock  at  a  lower  price  in  order  to  deliver  it  to 
the  person  to  whom  his  broker  originally  sold  the 
stock.  If  the  stock  goes  up  instead  of  down,  he  must 


INVESTMENT  AND   SPECULATION  317 

still  buy  it  in  order  to  make  delivery  to  his  purchaser. 
He  buys  therefore,  at  a  higher  price  than  that  at 
which  he  sold  and  so  loses  on  the  transaction.  Again 
there  is  no  investment,  for  he  sells  before  he  owns 
the  stock  and  as  soon  as  he  does  own  any  he  transfers 
it  to  his  original  purchaser. 

Grain  and  Produce  Speculation  —  The  same  meth- 
ods are  used  in  the  speculation  in  grain  and  other 
produce.  Men  who  would  not  know  the  difference 
between  wheat  and  barley  if  they  saw  the  two  together 
may  speculate  on  the  crop  markets.  Crops  are  bought 
and  sold  before  the  seed  is  planted  and  the  total  amount 
of  transactions  probably  far  exceeds  the  total  value 
of  the  crop  when  it  is  actually  reaped. 

Speculation  and  the  Stability  of  Prices  —  Theoreti- 
cally it  is  often  argued  that  the  speculation  in  futures 
tends  toward  stabilizing  prices,  that  is,  preventing 
the  extension  of  the  price  fluctuations.  The  argument 
is  simple  enough  —  we  have  already  outlined  it  in 
regard  to  investment.  If  prices  are  high  at  present 
and  the  speculators  believe  that  they  will  fall,  they 
sell.  But  the  fact  that  they  sell  now  tends  to  lower 
the  price.  As  soon  as  the  price  seems  likely  to  increase 
they  buy,  thus  helping  the  price  to  rise.  But  as  they 
prevent  a  high  price  from  going  higher  and  a  low  price 
from  going  lower,  they  are  therefore  helping  to  keep 
prices  level.  This  argument  is  not  true  to  the  facts, 
however,  for  it  is  seldom  that  a  speculator  sells  in  a 
market  which  is  rising.  He  usually  "  follows  the 
market."  If  he  sees  prices  falling,  he  acts  on  the 
opinion  that  they  will  fall  farther  and  hence  helps 
them  to  fall.  If  they  rise  he  seems  to  believe  that 


318  AN   INTRODUCTION   TO   ECONOMICS 

they  will  rise  farther  and  so  he  buys,  thus  helping  the 
price  to  climb. 

As  a  matter  of  fact,  there  cannot  be  the  slightest 
doubt  in  practice  that,  far  from  helping  to  stabilize 
prices,  speculation  tends  to  increase  the  fluctuation, 
even  when  it  does  not  do  so  deliberately. 

In  the  stock  market  the  prices  that  are  paid  for 
stock  often  have  not  the  remotest  connection  with 
the  actual  value  of  the  stock.  For  example,  we  may 
cite  the  price  of  Northern  Pacific  stock  which  went 
as  high  as  $1000  for  the  $100  share  during  the  fight 
between  James  J.  Hill  and  E.  H.  Harriman  for  control 
of  the  road.  This  price  was  absolutely  unconnected 
with  the  actual  value  of  the  shares  in  that  railroad 
company.  Again  in  the  famous  Boston  gas  war, 
the  prices  of  shares  had  no  relation  to  the  normal 
value  of  the  stock  of  the  various  companies  concerned. 

Psychological  factors  are  of  immense  importance 
in  the  stock  market.  A  stockholder  may  be  thor- 
oughly convinced  that  his  stock  is  worth  what  he 
paid  for  it.  But  let  him  see  continuous  heavy  sales 
at  lower  and  lower  prices  and  he  will  feel  more  and 
more  uncertain.  As  the  prices  fall  he  will  gradually 
feel  that  he  must  realize  on  his  holding  at  once  lest 
their  value  disappear.  This  psychological  factor  is 
realized  by  the  stock  manipulators  and  it  is,  unfor- 
tunately, no  uncommon  thing  for  a  valuable  stock  to 
be  "  beared  "  so  that  the  "  bears  "  may  afterwards 
buy  it  in  at  a  small  price. 

Control  of  Speculation  —  The  control  of  speculation 
is  extraordinarily  difficult.  It  is  admitted  that  the 
genuine  purchase  and  sale  of  stocks  is  valuable  as 


INVESTMENT   AND   SPECULATION  319 

society  is  organized  at  present.  But  there  is  no  differ- 
ence in  technique  between  a  genuine  sale  and  pur- 
chase and  a  speculative  one.  Hence  schemes  which 
would  effectually  control  speculation  at  the  same  time 
control  investment.  The  stock  exchange  has  rules 
which  must  be  observed  by  its  members.  But  there  are 
always  the  curb  brokers  and  there  are  ways  of  break- 
ing the  rules  without  appearing  to  do  so.  We  have 
no  space  to  go  into  the  technique  further.  The  ques- 
tion of  the  control  and  regulation  of  stock  exchange 
gambling  is  one  which  must  receive  careful  attention 
by  the  public  and  its  representatives  in  Congress. 


CHAPTER  XXIV 

RENT,  INTEREST,  AND  PROFITS 

Distribution  as  an  Economic  Problem  —  Much 
of  our  previous  discussion  has  been  concerned  with 
the  problems  of  production  and  exchange.  We  must 
now  turn  to  another  element  in  economic  life  —  the 
distribution  of  the  products.  This  problem  is  not 
to  be  confused  with  the  difficulty  of  mechanical  trans- 
portation. The  word  distribution  is  used  in  another 
sense.  When  goods  have  been  produced  there  always 
arises  the  question  as  to  the  ownership  of  the  goods. 
When  work  has  been  done  there  arises  the  question 
as  to  the  price  to  be  paid  for  the  labor.  If  we  consider 
labor  merely  as  a  peculiar  form  of  goods,  then,  of 
course,  we  can  deal  with  it  under  the  general  laws 
of  exchange  which  have  already  been  discussed.  We 
shall  see,  however,  that  labor,  or  rather,  laborers 
refuse  to  allow  themselves  to  be  considered  in  that 
manner  nowadays.  Indeed  it  is  not  only  the  laborers 
who  refuse.  Governments  also,  in  every  civilized 
country,  take  certain  steps  to  prevent  labor  from  being 
so  regarded.  Let  us  put  the  problem  concretely. 
Suppose  a  factory  turns  out  goods  which  are  sold  for 
one  million  dollars.  Suppose  further  that  the  cost 
of  the  materials  from  which  those  goods  were  made 
amounted  to  $250,000.  How  is  the  balance  to  be 
divided  ? 

320 


RENT,   INTEREST,   AND 'PROFITS  321 

Now  in  any  ordinary  concrete  case  it  is  simple  to 
enumerate  the  different  recipients.  In  the  first  place 
the  laborers  (including  within  the  term  those  who  work 
by  brain  as  well  as  hand  workers)  must  receive  a  cer- 
tain share.  Those  who  supply  the  capital  require 
a  certain  amount  for  the  loan.  Those  who  provide 
the  land  and  buildings  upon  and  in  which  the  goods 
are  made  must  receive  their  payment.  If  anything 
is  left  we  may  provisionally  regard  it  as  profits. 

This  is  one  aspect  in  which  the  problem  of  distribu- 
tion may  be  regarded.  It  is  impersonal,  for  we  are 
merely  trying  to  divide  the  proceeds  into  the  ratios 
suitable  to  the  value  of  the  different  factors  in  pro- 
duction —  land,  labor,  and  capital.  There  is  another 
aspect,  however,  which  is  of  considerable,  if  not  of 
paramount,  importance.  One  of  the  greatest  problems 
which  confronts  the  economic  world  is  the  problem 
of  riches  and  poverty.  Why  should  one  man  receive 
a  great  share  of  the  proceeds  of  the  world's  economic 
efforts,  and  many  others  have  to  accept  very  small 
portions?  In  simple  words,  why  should  one  man 
be  poor  and  another  rich?  We  may  speak  of  that 
problem  as  the  problem  of  the  personal  distribution 
of  wealth  to  distinguish  it  from  the  first. 

In  this  latter  form  of  distribution  the  ethical  aspect 
is  of  great  importance  and  cannot  be  ignored.  It  is 
too  important  to  be  considered  in  a  subsection  and 
will,  therefore,  be  dealt  with  more  fully  in  the  next 
chapter.  The  discussion  of  the  distribution  between 
the  various  factors  of  production  may  be  considered 
purely  analytically,  and  the  present  chapter  will  deal 
with  the  reasons  for  the  payment  of  rent,  interest,  and 


322  AN  INTRODUCTION   TO   ECONOMICS 

profits,  leaving  the  wage  question  for  future  con- 
sideration. 

It  is  important  to  realize,  however,  that  in  discussing 
these  reasons  we  are  not  necessarily  implying  that 
rent  and  interest  and  profits  are  inevitable  under 
any  system  of  economic  organization.  The  fact  is 
that  payments  are  made  to  the  owners  of  land,  to  the 
owners  of  capital,  and  to  the  owners  or  operators  of 
businesses  and  it  is  important  to  realize  why  these 
payments  are  made. 

Rent  —  Let  us  suppose  that  in  a  certain  community 
there  is  available  for  agricultural  purposes  1000  acres 
of  land,  and  also  that  the  only  crop  is  wheat.  If  all 
this  land  is  of  equal  quality  and  can,  therefore,  produce 
wheat  at  an  equal  cost,  no  question  of  differences  in 
payment  for  the  land  can  arise.  If  the  cost  of  raising 
wheat,  including  the  payment  for  the  necessary  farm 
labor,  seeding,  depreciation  of  implements  etc.,  be 
30  cents  a  bushel,  then  the  wheat  cannot  be  sold 
for  less  than  that  amount  (we  must  ignore  temporary 
and  peculiar  conditions  of  different  farmers).  If  it 
were,  the  wheat  would  cease  to  be  produced.  Now 
if  the  wheat  is  just  sufficient  for  the  needs  of  the  com- 
munity, the  price  will  be  just  equal  to  the  cost  of  pro- 
duction, i.e.,  30  cents  a  bushel.  It  cannot  go  above 
30  cents,  for  if  it  did  competition  between  the  farmers 
would  bring  it  back  again. 

Our  assumption,  however,  is  never  warranted  by 
the  facts.  The  land  is  not  of  the  same  quality  through- 
out. If  all  be  capable  of  producing  wheat,  the  cost 
of  production  will  vary  with  different  farms.  One 
farmer  will  be  able  to  produce  at  30  cents  a  bushel, 


RENT,   INTEREST,   AND   PROFITS  323 

but  another  will  only  be  able  to  raise  his  wheat  at 
a  cost  of  35  cents,  another  at  37  cents,  and  so  on.  Now 
suppose  there  is  sufficient  land  of  the  highest  quality 
to  produce  all  the  wheat  desired  by  the  community 
at  a  cost  of  30  cents  a  bushel.  Obviously  only 
the  best  land  will  be  cultivated.  The  demand  will 
exactly  equal  the  supply.  Now  suppose  the  demand 
goes  beyond  the  amount  which  can  be  produced  at 
30  cents  a  bushel.  Suppose,  for  instance,  that 
the  competition  for  wheat  raises  the  price  to  35  cents. 
In  that  case  it  is  worth  while  for  the  farmer  to  culti- 
vate some  of  the  poorer  land.  This  means,  however, 
that  those  who  till  the  better  land  gain  an  extra  price, 
above  the  cost  of  their  labor,  etc.,  of  5  cents  a  bushel. 
In  order  to  obtain  this  increase  farmers  will  be  willing 
to  offer  payment  for  the  use  of  this  better  land.  If 
30  bushels  to  the  acre  are  produced,  the  farmers  will 
be  willing  to  pay  a  sum  not  exceeding  $1.50  an  acre 
for  the  use  of  this  land.  If  they  make  that  payment, 
they  still  have  the  opportunity  of  selling  their  wheat 
at  a  price  which  will  repay  them  for  the  cost  of  pro- 
duction. No  one,  however,  will  be  willing  to  pay 
for  the  cheaper  land,  for  the  price  to  be  gained  is  only 
sufficient  to  pay  for  cost  of  production. 

This  price  paid  for  the  use  of  the  better  land  is 
known  as  rent.  The  student  will  naturally  reply 
to  this  statement,  that  rent  is  paid  even  for  the  poorest 
land  that  is  cultivated  and  that  some  of  the  best  land 
is  worked  by  the  owner  who  pays  no  rent.  Let  us 
examine  this.  All  land  upon  which  wheat  can  be 
grown  is  not  cultivated.  The  reason  why  some  is 
not  used  is  that  the  price  to  be  obtained  from  the  wheat 


324  AN   INTRODUCTION   TO   ECONOMICS 

is  not  sufficient  to  repay  the  cost  of  cultivating  it. 
Also,  it  is  a  fact  that  the  poorer  the  land,  the  smaller 
the  rent  which  is  actually  paid.  Now,  if  the  demand 
for  wheat  is  such  that  the  existing  supply  from  the 
cultivated  land  is  not  sufficient,  the  price  will  rise 
until  it  reaches  the  point  where  the  hitherto  unculti- 
vated land  is  worth  farming.  This  means  that  a  rent 
will  be  offered  for  the  land  which  was  of  the  poorest 
quality  actually  cultivated  before,  for  this  land  is 
now  able  to  produce  wheat  which  sells  at  a  higher 
price  than  that  necessary  merely  to  repay  the  farmer 
for  his  cost  of  production.  It  is  obvious  that  no  one 
will  pay  for  anything  which  means  a  steady  loss  to 
him.  Hence  nothing  will  be  paid  for  the  land  which 
merely  repays  the  cost  of  production  of  the  wheat. 
This  land  may  be  said  to  be  on  the  margin  of  cultiva- 
tion, for  it  is  the  last  to  be  cultivated.  Any  land  which 
is  above  the  margin  of  cultivation  earns  a  rent. 

Now  as  to  the  non-payment  of  rent  by  the  owner  of 
high-class  land  which  he  farms  himself.  In  selling 
his  produce  he  receives  more  than  is  necessary  to 
repay  the  cost  of  production.  It  is  assumed  that  he 
will  farm  the  land  even  if  he  does  not  get  this  addi- 
tional price.  Therefore  the  increase  in  price  over 
the  cost  of  production  is  in  the  nature  of  a  producer's 
surplus,  and  is  to  be  regarded  as  rent  which  he  pays 
to  himself.  Obviously,  if  he  were  to  relinquish  farm- 
ing himself,  and  turn  the  farm  over  to  a  tenant,  the 
latter  would  pay  a  rent.  Whether  the  rent  is  paid 
to  the  farmer  himself,  as  owner,  or  by  a  tenant  to  the 
owner,  is  immaterial. 

The  rent  is  a  payment  made  for  the  inherent  qualities 


RENT,    INTEREST,   AND   PROFITS  325 

of  the  land,  the  qualities  endowed  by  nature.  Rent 
only  appears  when  other  lands  of  poorer  quality  are 
forced  into  cultivation  by  the  demand  for  the  agri- 
cultural product. 

Urban  Rents  —  Rent  is  not  only  paid  for  agri- 
cultural land,  however.  It  is  also  paid  for  land  in 
cities  where  no  agriculture  is  carried  on.  A  man  pays 
"rent"  for  the  use  of  a  building.  This  use  of  the 
word  rent,  however,  is  not  accurate  according  to  our 
definition.  The  payment  is  made  not  for  one  reason, 
but  for  two.  In  the  first  place  it  is  made  for  the  land 
upon  which  the  building  is  situated.  Secondly,  it 
is  made  for  the  use  of  the  building  itself.  But  the 
building  is  not  a  natural  product.  It  gradually  deteri- 
orates with  age.  The  payment  for  its  use,  therefore, 
is  rather  a  payment  for  the  building  itself  upon  the 
installment  principle.  There  comes  a  time  when  the 
building  is  no  longer  of  any  value;  it  has  served  its 
purpose  and  become  worn  out.  No  "  rent  "  will  be 
paid  for  it  then.  So  the  rent  paid  in  a  city  is  still 
to  be  regarded  as  a  payment  for  natural  values. 

The  natural  values  of  urban  land,  however,  are 
not  the  same  as  those  of  agricultural  land.  In  the 
city  the  land  value  varies  according  to  its  situation. 
If  it  is  to  be  used  for  the  purpose  of  selling  goods, 
the  rent  will  depend  upon  its  comparative  value  as 
a  suitable  situation.  More  will  be  paid  for  land  in 
the  shopping  center  of  the  city  than  in  the  outlying 
districts.  Land  upon  which  offices  are  to  be  built 
will  command  a  higher  rent  if  situated  near  the  com- 
mercial center.  If  factories  are  to  be  erected,  then 
the  higher  rents  will  be  paid  for  those  situations  which 


326  AN  INTRODUCTION   TO   ECONOMICS 

are  close  to  good  transportation  facilities.  In  every 
case,  however,  the  principle  is  the  same  as  in  that  of 
agricultural  land.  We  may  define  rent,  therefore, 
as  the  amount  paid  for  the  use  of  land  in  excess  of 
the  amount  paid  for  land  on  the  margin  of  cultivation. 

Quasi  Rents  —  The  idea  of  economic  rent  has  been 
extended  outside  the  consideration  of  the  natural 
values  of  land.  Some  of  the  improvements  made  in 
past  times  have  practically  been  incorporated  in  the 
land  —  ancient  irrigation  works,  clearing  of  forest 
growths,  and  so  on.  These  are  not  gifts  of  nature, 
but  nevertheless,  they  give  the  land  a  comparative 
advantage  in  production  which  is  somewhat  like  the 
gifts  of  nature  and  hence  payment  for  this  advantage 
is  of  the  nature  of  rent. 

Again  it  is  sometimes  said  that  a  man  who  has 
peculiar  natural  advantages  obtains  a  "•  rent "  for 
them.  In  the  case  of  two  piece  workers,  for  instance, 
one  of  whom  is  quicker  and  more  accurate  than  the 
other,  the  quicker  man  will  be  able  to  earn  more  in 
a  day  than  the  slower,  so  the  amount  he  receives  in 
excess  of  that  paid  to  the  other  is  somewhat  similar 
to  rent.  These  forms  of  rent  are,  however,  better 
known  as  quasi  rents. 

Interest  —  The  next  element  to  share  in  the  dis- 
tribution of  the  produced  wealth  is  capital.  Pay- 
ment for  the  use  of  capital  is  termed  interest.  We 
have  already  seen  that  in  the  Middle  Ages  interest 
was  regarded  as  immoral,  and  we  have  examined  the 
reasons  for  that  idea.  We  must  now  analyze  the 
reasons  for  the  payment  for  the  use  of  capital.  It  has 
sometimes  been  argued  that  interest  is  paid  because 


RENT,    INTEREST,   AND   PROFITS  327 

the  owner  of  the  capital  might  have  made  a  profit  by 
using  the  capital  himself  and  that,  as  he  foregoes  the 
profit  which  he  might  have  made,  he  is  entitled  to 
share  in  the  profits  made  by  the  actual  user.  There 
is  a  great  deal  of  truth  in  this  argument,  but  it  does 
not  quite  cover  the  ground.  Many  men  ask  and 
receive  interest  for  the  use  of  their  capital,  who  would 
be  unable  to  make  any  personal  use  of  their  funds  as 
capital. '  Take,  for  instance,  the  man  with  a  small 
savings  account.  The  amount  which  he  possesses 
may  be  so  small  that  he  is  unable  to  finance  a  business, 
and  the  probability  is  that  he  is  merely  a  wage  earner 
himself  and  so  does  not  provide  capital  for  the  business 
through  which  he  gains  his  living.  Nevertheless 
he  expects  to  receive  interest  from  his  savings  bank. 
Again,  a  man  may  have  sufficient  capital  to  work  the 
business  in  which  he  is  principally  engaged.  His 
business  may  be  at  the  stage  of  diminishing  returns. 
Any  addition  to  the  capital,  therefore,  would  mean  a 
return  smaller  proportionately  than  that  gained  by 
the  actual  capital.  Unless  he  has  some  other  business 
to  which  he  gives  his  personal  attention  he  is  unable 
to  employ  that  spare  capital.  Hence  it  would  appear 
that  he  is  not  entitled  to  anything  more  than  the 
return  of  his  investment  when  he  lends  the  capital. 

There  is  another  reason  for  the  payment  of  interest, 
however,  which  is  more  complete  than  the  one  we 
have  just  spoken  of.  In  the  discussion  of  the  prin- 
ciple of  marginal  utility  it  was  shown  that  there  is  a 
great  difference  in  the  marginal  utility  of  a  present 
satisfaction  and  a  similar  satisfaction  in  the  future. 
Invariably  the  present  satisfaction  has  a  higher  mar- 


328  AN  INTRODUCTION   TO   ECONOMICS 

ginal  utility  than  the  future.  Now  when  a  person 
invests  his  capital  he  is  denying  himself  a  present 
satisfaction.  In  other  words  he  is  denying  himself 
the  satisfaction  which  he  could  obtain  by  buying 
consumption  goods.  In  the  case  of  the  man  with  the 
small  savings  account,  it  is  quite  possible  that  the 
amount  saved  could  have  been  used  for  the  purchase 
of  some  little  luxury  which  would  have  been  keenly 
appreciated.  Many  thousands  of  these  small  savings 
represent  real  sacrifices  of  present  utilities.  It  is 
only  right,  therefore,  that  the  return  of  the  capital 
saved  should  be  accompanied  by  some  amount  repre- 
senting the  difference  between  the  present  and  the 
future  utility.  Let  us  take  the  famous  illustration 
of  the  man  who  makes  a  plane,  and  lends  it  to  a  car- 
penter for  a  year.  The  maker  of  the  plane  demands 
at  the  end  of  the  year  the  return  of  the  plane  in  as  good 
condition  as  it  was  when  he  lent  it,  together  with  a 
plank  of  wood.  The  argument  here  is  not  that  the 
plane-maker  could  have  used  the  plane  himself  during 
the  period  of  the  loan,  but  that  he  might  have  expended 
the  energy  used  in  the  manufacture  to  make  something 
which  would  have  satisfied  an  immediate  want.  The 
carpenter  who  used  the  plane  has  produced  goods  in 
excess  of  the  value  of  the  plane  itself,  and  as  he  has  ob- 
tained present  utilities  from  its  use  he  must  recompense 
the  lender  for  his  abstinence  from  a  present  satisfaction. 
The  real  justification  for  the  payment  of  interest, 
therefore,  is  the  fact  that  the  lending  of  capital  means 
an  abstinence  from  present  satisfaction  and  that  there- 
fore the  lender  is  entitled  to  the  difference  between  the 
present  and  the  future  marginal  utility. 


RENT,    INTEREST,   AND   PROFITS  329 

It  may  still  be  argued,  of  course,  that  there  are 
certain  men  whose  wealth  is  so  great  that  they  cannot 
spend  anything  like  the  whole  of  it  on  consumption 
goods,  and  hence  there  is  no  real  abstinence  from  present 
satisfaction  on  their  part.  This  argument,  however, 
brings  in  another  consideration,  involving  the  question 
of  the  personal  distribution  of  wealth.  It  does  not 
affect  the  statement  that  the  purchase  of  consumption 
goods,  i.e.,  the  purchase  of  present  utilities  is  foregone, 
and  the  difference  between  present  and  future  utilities 
must  be  paid  for. 

The  question  of  the  causes  determining  the  rate  of 
interest  is  too  complicated  for  our  present  discussion, 
but  a  brief  statement  may  be  given.  In  the  first 
place,  security  for  the  return  of  the  principal  is  impor- 
tant. Assuming,  however,  that  security  is  the  same 
throughout,  then  the  rate  of  interest  will  be  determined 
by  a  sort  of  average  of  the  estimated  difference  between 
present  and  future  utilities.  The  average  will  be 
arrived  at  to  a  large  extent  by  the  relations  between 
the  supply  and  demand  of  investment  capital. 

Profits  —  In  general  the  term  profits  is  used  to  in- 
clude the  payment  of  interest  on  capital,  while  rent  and 
wages  are  included  in  the  cost  of  production.  This, 
however,  is  merely  the  colloquial  use  of  the  term  and 
we  must  eliminate  these  elements.  So  far,  we  have 
considered  the  returns  from  the  sale  of  the  goods  or 
services  as  having  provided  for  payment  of  cost  of 
materials,  for  rent,  and  for  interest  on  invested  capital. 
It  does  not  matter,  of  course,  whether  the  owner  of  the 
capital  conducts  the  business  himself  or  not.  A  cer- 
tain amount  is  due  for  interest.  There  is,  presumably, 


330  AN  INTRODUCTION  TO   ECONOMICS 

a  greater  return  than  would  be  sufficient  for  these 
payments,  even  assuming  that  labor  has  been  allowed 
for  in  estimating  the  costs  of  production.  The  pay- 
ment for  managerial  efforts  and  skill  is  rightly  to  be 
included  in  the  cost  of  labor,  and  what  is  left  over 
constitutes  the  profits. 

If  we  consider  that  rent,  interest,  and  wages  (includ- 
ing wages  of  management)  have  all  been  paid  for, 
what  justification  is  there  for  profits  beyond  these 
amounts?  There  are  two  answers  to  this  question. 
One  is  that  profits  are  rightly  to  be  considered  as  a 
form  of  rent.  The  entrepreneur,  that  is,  the  man  who 
undertakes  to  conduct  the  business,  has  a  certain 
amount  of  ability.  The  ability  of  different  entre- 
preneurs varies,  however.  He  who  is  simply  able  to 
make  sufficient  by  his  conduct  of  the  business  to  pay 
for  wages,  rent,  and  interest,  is  in  the  position  of  the 
farmer  on  the  margin  of  cultivation.  One  who  makes 
more  than  that  is  reaping  the  reward  of  his  additional 
ability.  He  is  thus  in  the  position  of  the  farmer  whose 
land  is  of  better  quality  and  thus  a  rent  is  paid. 

There  is  something  to  be  said  for  this  view.  There 
does  appear  to  be  considerable  similarity  between 
the  two  positions  and  hence  profits  might  be  said  to 
be  a  form  of  quasi  rent.  There  are,  however,  other 
reasons  which  tend  to  refute  the  argument.  In 
particular  there  is  the  question  of  risk  taking.  The 
undertaker  has  to  assume  risks  which  the  mere  lender 
of  capital  does  not  take.  There  are  very  many  unfore- 
seen risks  that  are  inherent  in  all  businesses.  Take 
the  case  of  the  cloth  manufacturer,  for  instance.  He 
manufactures  cloth  of  a  color  to  suit  the  existing  ideas. 


RENT,   INTEREST,   AND   PROFITS  331 

The  fashions  may  change  in  a  day,  however,  and  new 
colors  may  be  demanded.  The  stock  of  the  old  colors 
may  be  sold  at  a  loss.  Again  he  may  be  manufacturing 
in  a  certain  situation  where  the  transportation  facilities 
are  good.  Gradually  these  facilities  disappear;  the 
mouth  of  a  river  silts  up,  or  a  landslide  occurs  on  the 
railroad  and  for  months  the  track  is  useless ;  floods 
prevent  passing  of  railway  trains,  and  so  forth.  Again 
a  war  may  occur  which  prevents  him  from  obtaining 
a  proper  supply  of  raw  materials.  All  these  are  risks 
which  he  must  take. 

Most  of  these  risks  may  be  estimated  mathematically 
according  to  the  laws  of  chance.  Actuaries  make  a 
profession  of  estimating  such  chances.  Each  indi- 
vidual entrepreneur  must  also  estimate  the  chances 
of  loss  by  such  risks.  He,  however,  does  not  as  a  rule 
estimate  the  chances  mathematically,  but  rather 
makes  what  we  may  call  a  subjective  estimate  which 
is  invariably  greater  than  the  mathematical  estimate. 
In  order  to  be  on  the  safe  side  he  strives  to  obtain  a 
price  for  his  products  which  will  enable  him  to  bear 
unforeseen  losses  when  they  occur.  The  community 
has  to  bear  the  losses  in  fact,  of  course,  but  they  are 
as  it  were  distributed  over  a  large  area.  The  increased 
price  relieves  the  consumer  of  any  responsibility  for 
the  losses.  If  there  were  no  such  insurance  of  risk, 
it  is  doubtful  whether  production,  under  the  present 
economic  organization,  could  take  place. 

To  make  a  final  analysis  of  profits,  therefore,  we  may 
say  that  they  consist  of  insurance  against  risk  and  rent 
of  ability.  In  speaking  of  the  insurance  against  risk, 
of  course,  we  must  not  take  the  subjective  estimate, 


332  AN    INTRODUCTION   TO   ECONOMICS 

for  that  is  too  high.  We  mean  the  mathematical 
estimate.  This,  however,  as  we  have  said,  is  not  the 
business  man's  method.  He  attempts  to  obtain  as 
much  as  possible,  merely  making  sure  that  the  mini- 
mum is  equal  to  his  subjective  estimate  of  the  risks 
encountered  in  the  conduct  of  the  business. 

Summary  Analysis  —  The  distribution  of  the  pro- 
ceeds of  industry,  therefore,  may  be  summed  up  as 
follows : 

1.  Rent,  or  payment  for  the  use  of  land. 

2.  Interest,  or  payment  for  the  use  of  capital. 

3.  Wages,  or  payment  for  labor,    including    the    labor    of 

management. 

4.  Profits  including  : 

(a)  Insurance  against  risks. 
(6)  Rent  of  ability. 


CHAPTER  XXV 

THE   PERSONAL   DISTRIBUTION   OF   WEALTH 

There  are  few  problems  which  involve  more  con- 
troversy than  that  of  the  personal  distribution  of 
wealth.  Ought  each  individual  to  receive  an  equal 
share  of  the  total  product,  or  is  his  share  determined 
'by  causes  over  which  society  exercises  no  control? 
If  there  exists  inequality,  as  no  one  doubts,  is  the 
inequality  growing  greater  as  time  passes,  or  less? 
If  there  is  a  difference,  to  what  is  the  difference  due? 
We  shall  attempt  an  answer  to  some  of  these  questions 
in  the  present  chapter.' 

Statistics  —  The  first  difficulty  which  arises  is 
that  of  securing  accurate  data  upon  which  to  base 
conclusions.  This  involves  the  use  of  statistics,  and 
statistics  are  very  difficult  both  to  collect  and  to 
interpret.  To  attempt,  in  a  book  like  the  present,  to 
discus's  the  statistics  of  the  distribution  of  wealth 
is  quite  impossible.  It  is  well  to  warn  the  student, 
also,  that  statistics  is  a  difficult  science,  and  none  the 
less  so,  because  many  people  think  that  they  are  using 
statistics  when  they  are  only  quoting  figures.  Instead 
of  giving  actual  figures  and  reasoning  therefrom,  we 
shall  have  to  content  ourselves  with  stating  some  gen- 
eral conclusions  at  which  statisticians  have  arrived 
after  careful  consideration  of  the  data  obtainable 
333 


334  AN  INTRODUCTION   TO   ECONOMICS 

not  only   from   American,    but   also   from   European 
sources. 

The  Present  Condition  —  There  can  hardly  be  any 
doubt  that  the  economic  condition  of  every  class  has 
improved  greatly  during  the  last  century  or  two. 
We  must  always  remember  that  there  exists  a  strong 
tendency  to  overestimate  the  evils  of  the  present 
when  comparing  them  with  those  of  the  past.  It  is 
commonly  said,  for  instance,  that  the  early  colonists 
of  this  country  lived  in  a  state  of  rude  comfort;  a 
general  largeness  of  living  is  suggested.  As  a  matter 
of  fact,  more  stress  should  be  laid  upon  the  rudeness 
than  upon  the  comfort.  The  early  colonist  lived  in 
a  constant  struggle  against  starvation.  He  had  no 
comforts  that  would  not  be  scorned  nowadays  by 
even  the  poorest.  His  working  day  covered  the  whole 
of  the  daylight  and  often  part  of  the  night.  Our 
very  awareness  of  the  evils  of  the  present  conditions 
is  an  indication  of  improvement.  But  while  we  refrain 
from  underestimating  the  improvement,  we  must 
not  be  blind  to  the  existence  of  evils.  Without  detail- 
ing the  failures  of  the  modern  system  to  secure  an  equi- 
table distribution  of  the  world's  wealth,  we  may  at 
least  mention  a  few  of  the  more  notorious  facts.  On  the 
one  hand  we  see  the  growth  of  personal  fortunes  which 
are  beyond  the  wildest  dreams  of  the  oriental  potentates 
of  old.  Croesus  was  a  member  of  the  lower  middle 
classes  compared  with  some  of  the  money  kings  of 
to-day.  On  the  other  hand  we  find  that  in  any  great 
city  of  the  world  a  large  proportion  of  the  population 
do  not  receive  enough  to  maintain  themselves  in  a 
state  of  bodily  efficiency.  It  is  estimated,  for  instance, 


THE   PERSONAL   DISTRIBUTION   OF  WEALTH     335 

that  in  order  to  maintain  himself  and  his  family  of 
three  children  in  a  state  of  bare  physical  efficiency, 
without  allowing  for  the  slightest  luxury,  even  for 
cheap  amusement  or  an  occasional  pipe  of  tobacco, 
a  workman  ought  to  receive  about  $1600  per  annum. 
It  is  further  estimated  that  the  average  rate  of  pay  for 
the  American  workman  is  less  by  some  hundreds  of 
dollars  than  that  sum,  after  allowance  is  made  for 
periods  of  unemployment.  As  we  have  said,  the 
statistics  of  the  subject  are  essential  in  making  an 
accurate  estimate  of  the  inequalities  of  distribution 
of  wealth,  but  for  our  present  purpose  we  may  assume 
that  these  inequalities  exist  and  we  may  now  proceed 
to  discuss  some  of  the  causes  which  produce  great 
wealth  and,  later,  some  of  those  which  result  in  great 
poverty. 

The  Causes  of  Wealth  —  It  is  well  to  remember 
that  we  seldom  find  one  cause  working  alone.  That 
does  not  destroy  the  value  of  an  analysis,  however. 
We  shall  not  pretend  that  our  analysis  is  absolutely 
complete,  or  that  it  is  always  scientifically  accurate. 
There  are  occasions  when  it  is  almost  impossible  to 
separate  one  cause  from  another.  We  may,  however, 
consider  that  there  are  four  chief  factors  in  the  pro- 
duction of  great  fortunes.  (1)  Accidental  causes, 
or  those  over  which  the  fortunate  individuals  who 
gain  the  wealth  have  had  no  control.  (2)  Opportunity, 
often  very  similar  to  accidental  causes,  but  differing 
in  that  often  the  individual  must  exercise  considerable 
judgment  in  discerning  the  existence  of  and  in  seizing 
the  opportunity.  (3)  Efficiency,  where  the  wealth 
resultant  is  due  to  the  superior  capacity  of  him  who 


336  AN   INTRODUCTION   TO   ECONOMICS 

has  gained  it.  (4)  Monopoly,  where  the  wealth  is  due 
to  the  possession  of  monopolistic  privileges. 

i.  Accidental  Causes  —  Accidental  wealth  is  often 
due  to  the  discovery  of  unexpected  mineral  deposits. 
It  may  happen,  for  instance,  that  a  man  buys  a  farm, 
and  later  on  discovers  that  the  underlying  earth  con- 
tains a  valuable  bed  of  coal  or  some  other  mineral. 
The  value  of  the  land  jumps  at  once  to  a  sum  vastly 
greater  than  that  which  was  given  for  the  land  on 
the  basis  of  its  agricultural  value.  Before  the  dis- 
covery of  the  great  value  of  mineral  oil,  for  example, 
much  of  the  land  upon  which  oil  wells  have  been  drilled 
was  of  comparatively  little  value.  The  fact  that  the 
presence  of  oil  is  unknown  to  the  individual  who  pos- 
sesses the  land  makes  that  presence  a  hidden  factor 
in  the  value  of  the  land.  The  accidental  discovery 
of  the  oil  is  not  due  to  the  efforts  of  the  individual, 
beyond,  perhaps,  the  expenditure  of  effort  on  a  few 
experimental  borings,  but  nevertheless,  the  discovery 
of  the  oil  may  easily  be  the  cause  of  a  great  fortune 
to  the  owner  of  the  land.  Two  farmers  have  adjacent 
farms;  each  bores  for  water,  and  one  discovers  oil 
instead.  His  farm  leaps  in  value,  while  his  neigh- 
bor's remains  stationary,  or  at  most,  rises  because  of 
proximity  to  the  oil  and  the  possibility  of  oil  existing 
there  also.  One  farmer  immediately  becomes  wealthy, 
while  the  other,  should  no  oil  be  found,  earns  his  living 
in  the  sweat  of  his  brow. 

Again  in  the  actual  search  for  minerals,  the  element 
of  accident  plays  a  great  part.  This  is  seen  in  almost 
all  of  the  great  gold  discoveries  in  California,  Alaska, 
Australia,  and  South  Africa.  Some  miners  will  spend 


THE   PERSONAL   DISTRIBUTION   OF  WEALTH     337 

the  whole  of  their  lives  in  the  search  for  gold,  with 
little  success.  Others,  of  no  greater  skill,  make  a  lucky 
strike  within  a  few  weeks  of  the  commencement  of  their 
prospecting.  The  lucky  ones  make  great  fortunes, 
while  their  equally  skillful  brethren  gain  a  bare  living. 

A  new  development  of  industry  may  cause  the 
manufacturer  of  a  hitherto  slightly  used  product 
suddenly  to  find  that  he  can  command  great  prices 
for  the  commodity  he  produces.  The  increase  in 
these  prices  may  be  due  to  causes  over  which  he  can- 
not exercise  the  slightest  control,  and  yet  he  gains  a 
great  profit.  The  illustration  of  this  which  leaps  to 
the  mind  is  that  of  the  rubber  industry.  Rubber 
was  known  before  its  great  uses  as  an  insulating  ma- 
terial in  the  electrical  industries  were  realized,  and 
the  invention  of  the  pneumatic  bicycle  and  motor 
tire  increased  the  demand  and,  consequently,  the  price 
to  a  tremendous  extent. 

Not  only  industrial,  but  also  social  developments 
may  cause  property,  hitherto  of  slight  value,  to  increase 
in  value  to  such  an  extent  as  to  make  the  owner  wealthy, 
and  this  without  the  slightest  exertion  on  his  part. 
The  development  of  a  city  in  one  direction  instead 
of  another  causes  great  inequalities  in  the  value  of 
lands  which  may  have  been  equal  before  the  develop- 
ment. Any  great  city  can  provide  instances  of  the 
beginnings  of  great  fortunes  through  such  increases 
in  land  values.  It  is  true  that  by  an  exercise  of  fore- 
sight certain  individuals  can  purchase  property  cheaply 
in  the  belief  that  some  future  developments  will 
increase  its  value,  but  that  does  not  take  away  the 
accidental  nature  of  the  resulting  fortune. 


338  AN  INTRODUCTION   TO   ECONOMICS 

2.  Opportunity  —  It  is  said  that  opportunity  knocks 
at  everybody's  door.  This  may  be  true,  but  it  is 
not  everybody  who  is  able  to  unlock  the  door.  The 
key  may  be,  in  the  business  world  at  any  rate,  in  the 
possession  of  the  controller  of  capital.  Many  oppor- 
tunities are  lost  not  so  much  for  want  of  recognition 
as  of  power  to  take  advantage  of  them.  There  is  a 
well-known  story  of  a  man  who  claimed  that  he  was 
once  offered  the  whole  of  the  site  of  Chicago  for  a 
pair  of  boots.  When  asked  why  he  did  not  make  the 
exchange,  he  replied  that  he  did  not  possess  the  boots. 
We  must,  therefore,  qualify  our  meaning  of  the  term 
opportunity,  by  considering  it  only  as  effective  oppor- 
tunity. Opportunity  is  of  no  value  to  the  man  who 
cannot  take  advantage  of  it. 

The  possession  or  the  control  of  the  means  to  take 
advantage  of  opportunity  may  be  the  result  of  any  of 
the  general  causes  of  wealth,  but  granted  its  posses- 
sion, the  opportunities  which  become  effective  consist 
essentially  of  two  kinds.  First  there  are  the  oppor- 
tunities which  arise  at  the  beginning  of  some  new 
industry  —  the  railroads,  for  instance.  We  have  al- 
ready pointed  out  in  a  previous  chapter  that  the  flow 
of  capital  is  not  steady,  but  that  it  moves  in  a  series 
of  jerks  or  leaps.  There  is  always  a  time  in  every 
new  business  when  the  cautious  man  waits  to  see  the 
results  before  he  invests  his  capital.  In  the  mean- 
time the  adventurous  have  seized  their  opportunity 
and  by  the  start  obtained,  have  sometimes  succeeded 
in  building  great  fortunes.  Provided,  one  assumes  the 
possession  of  the  necessary  original  capital,  the  wealth 
resultant  from  the  seizure  of  opportunity  may  be 


THE   PERSONAL   DISTRIBUTION   OF   WEALTH     339 

considered  as  due  to  the  foresight  of  the  individuals 
who  have  recognized  and  taken  advantage  of  the 
opportunity.  To  use  the  slang  phrase  of  the  business 
world,  there  are  opportunities  of  "  getting  in  on  the 
ground  floor."  Most  of  the  businesses  in  which  great 
fortunes  have  been  made  are  now  built  many  stories 
above  the  ground  floor.  To  change  the  metaphor, 
it  was  easily  possible  to  jump  into  the  train  when  it 
was  just  about  to  start,  but  now  that  it  is  moving 
at  sixty  miles  an  hour  the  chances  of  getting  crushed 
are  greater  than  those  of  reaching  the  carriage.  Ground 
floor  opportunities  nowadays  are  usually  based  on  the 
second  of  the  two  main  divisions,  the  possession  of 
private  knowledge. 

The  multitude  of  ways  in  which  private  and  exclusive 
knowledge  may  be  the  basis  of  great  fortunes  cannot 
all  be  described  here.  It  is  notorious,  however, 
that  in  the  financial  world,  many,  if  not  most  of  the 
great  fortunes  have  been  made  through  the  use  of 
private  and  exclusive  information.  The  methods  of 
the  stock  exchange  have  herein  played  their  part. 
To  give  a  single  and  common  illustration,  we  may 
point  out  the  advantage  which  is  taken  by  financiers 
who  have  information  of  the  increased  dividend  to 
be  paid  by  some  company.  They  buy  the  stock  of 
the  company  before  the  knowledge  of  the  new  dividend 
becomes  public  and  when  the  stock  is,  therefore, 
undervalued,  only  to  sell  when  the  price  rises  on  the 
declaration  of  the  dividend. 

3.  Efficiency  —  The  owners  of  great  wealth  almost 
always  claim  that  their  wealth  is  the  natural  reward 
of  their  efficiency.  A  careful  analysis  of  the  sources 


340  AN  INTRODUCTION   TO   ECONOMICS 

of  great  fortunes,  however,  tends  to  show  that  the 
element  of  efficiency,  at  least  in  so  far  as  it  concerns 
productive  efficiency,  does  not  play  too  prominent 
a  part.  Indeed  it  depends  very  greatly  upon  the 
actual  definition  of  efficiency  and  the  direction  in 
which  the  efficiency  is  applied,  which  makes  for  the 
importance  of  this  element  as  a  cause  of  wealth.  Under 
present  social  and  economic  organization  efficiency 
as  a  workman  will  never  bring  great  wealth  to  the 
workman.  There  is  greater  opportunity  for  the 
efficient  organizer,  but  even  that  opportunity  is 
greatly  overestimated.  Efficiency  in  financial  manip- 
ulation will  tend  very  strongly  to  build  up  a  great 
fortune,  but  that  is  not  the  type  of  efficiency  which  is 
usually  suggested.  If  it  could  be  shown  that  in  the 
majority  of  cases  the  efficient  workman,  teacher,  or 
manager  gained  great  wealth,  there  might  be  some 
reason  for  placing  importance  on  that  factor ;  but 
one  searches  in  vain  among  the  ranks  of  the  multi- 
millionaires for  the  one  whose  industrial  or  organizing 
efficiency  is  the  sole  cause  of  his  great  wealth.  That 
efficiency  plays  a  part,  we  cannot  doubt,  but  its  part 
is  more  obvious  when  we  consider  the  middle  groups 
of  society  rather  than  the  extremes. 

4.  Monopoly  —  The  effect  of  monopoly  as  a  factor 
in  the  production  of  great  fortunes  is  extremely  diffi- 
cult to  measure,  but  its  importance  can  hardly  be 
overestimated.  In  this  consideration  we  have  the 
advantage  of  knowing  the  results  of  a  careful  investi- 
gation into  the  causes  of  the  wealth  of  some  four 
thousand  millionaires.  The  investigation  shows  that 
"  about  seventy-eight  per  cent  of  the  fortunes  were 


THE    PERSONAL   DISTRIBUTION    OF   WEALTH      341 

derived  from  permanent  monopoly  privileges  and  only 
21.4  per  cent  from  competitive  industries  unaided  by 
natural  and  artificial  monopolies.  Yet  there  can  be  no 
question  that  if  these  21.4  per  cent  were  fully  analyzed 
it  would  appear  that  they  were  not  due  solely  to  per- 
sonal ability  unaided  by  these  permanent  monopoly 
privileges.  They  were  mostly  obtained  from  manu- 
factures, and  five  sixths  of  the  manufactures  of  the 
country  are  based  on  patents.  Besides,  fortunate 
investment  in  real  estate,  stocks,  etc.,  have  often 
contributed  to  great  fortunes  where  they  do  not  appear 
prominently.  Furthermore,  if  the  size  of  the  fortunes 
is  taken  into  account,  it  will  be  found  that  perhaps 
ninety-five  per  cent  of  the  total  values  represented 
by  these  millionaire  fortunes  is  due  to  those  investments 
classed  as  land  values  and  natural  monopolies  and  to 
competitive  industries  aided  by  such  monopolies."  l 

The  Causes  of  Poverty  —  The  causes  of  poverty 
necessitate  a  more  complicated  analysis  than  those 
of  wealth.  Much  more  attention  has  been  paid  by 
students  of  sociology  to  the  study  of  problems  of 
poverty  than  to  the  causes  and  effects  of  great  wealth. 
In  the  main,  however,  there  are  two  groups  into  which 
the  various  causes  of  poverty  may  be  separated,  and 
different  students  lay  different  stress  upon  one  or 
the  other.  The  general  consensus  of  opinion  at  present, 
however,  is  that  the  greater  proportion  of  poverty 
is  due  to  causes  closely  connected  with  industrial 
and  social  maladjustment,  and  the  lesser  amount  due 
to  personal  inefficiency  and  thriftlessness. 

It  is,  indeed,  often  argued  that  a  great  amount  of 

1  Commons,  The  Distribution  of  Wealth,  p.  252. 


342  AN  INTRODUCTION   TO   ECONOMICS 

poverty  is  inevitable;  that  the  fundamental  basis 
of  human  life  renders  poverty  a  necessity  either  in 
the  form  of  a  general  low  level  of  subsistence  or  else 
in  a  peculiarly  acute  form  of  poverty  suffered  by  a 
greater  or  less  portion  of  the  population,  balanced 
by  a  relative  comfort  on  the  part  of  the  remainder. 

This  argument  is  based  on  the  theory  that  popula- 
tion tends  to  increase  faster  than  the  production  of  the 
necessities  of  life,  and  hence,  unless  there  is  some  force 
at  work  which  causes  periodically  great  reductions 
in  population,  as,  for  instance,  war,  pestilence,  and 
famine,  the  total  dividend  of  necessaries  will  be  insuffi- 
cient to  provide  more  than  the  bare  limits  of  subsistence 
for,  at  any  rate,  a  large  proportion  of  the  population. 

Turning  now  to  the  two  main  categories  of  social 
and  industrial  maladjustment  and  personal  inefficiency 
or  thriftlessness,  we  find  considerable  room  for  argu- 
ment as  to  which  of  the  two  should  include  one  or 
other  of  the  subsidiary  causes  of  poverty.  The  pri- 
mary causes  of  poverty  have  been  well  analyzed  into 
seven  divisions :  1.  Old  age  and  sickness,  and  the 
death  of  the  principal  wage  earner.  2.  Unemploy- 
ment. 3.  Irregular  employment.  4.  Large  families. 
5.  Low  wages.  6.  Thriftlessness.  7.  Inefficiency. 

It  is  obvious  at  once  that  these  divisions  are  very 
closely  interrelated.  Unemployment  and  irregular 
employment  are  really  parts  of  the  same  problem, 
but  with  sufficient  differences  to  make  it  worth  while 
to  consider  them  separately.  Inefficiency  itself  may 
be  a  cause  of  low  wages,  or  of  irregular  employment, 
and  yet,  from  another  point  of  view,  may  be  an  effect 
of  these.  Sickness  and  premature  death,  also,  may 


THE   PERSONAL  DISTRIBUTION   OF  WEALTH      343 

be  due  to  low  wages  or  to  thriftlessness.  We  must 
attempt  to  decide,  as  accurately  as  we  can,  whether 
to  place  the  ultimate  blame  for  the  various  forms  of 
poverty  upon  social  or  industrial  maladjustment,  or 
upon  the  shoulders  of  the  individual  himself.  To  do 
this,  however,  involves  a  depth  of  study  which  cannot 
be  attempted  hepe.  We  may,  however,  sum  up  the 
conclusions  which  are  more  or  less  generally  accepted 
by  recognized  students  of  the  problems  of  poverty. 

It  is  undoubted  that  there  is  a  vast  amount  of 
thriftlessness  and  inefficiency,  but  it  is  also  obvious 
that  such  thriftlessness  and  inefficiency  are  not  always 
confined  to  the  poor.  If  wages  are  so  low  that  they 
suffice  merely  for  the  bare  necessities  of  life,  thrift 
is  impossible  without  danger  of  death  from  starvation 
resulting.  Thriftlessness  may  exist  and  does  exist  in 
the  wealthy  as  well  as  among  the  poor,  but  as  no 
complaint  comes  from  the  wealthy  there  has  been  no 
question  of  the  problem  of  thriftlessness  in  that  class. 
Inefficiency  is  common,  also,  with  the  possessors  of 
wealth,  but  as  society  does  not,  apparently,  have  to  pay 
for  such  inefficiency  (or  idleness  which  may  be  classed 
as  inefficiency),  again  there  has  been  no  problem  to 
discuss. 

In  fact  all  of  the  faults  of  the  poor  can  be  discovered 
in  a  greater  or  less  degree  among  the  rich.  These 
problems  involve  psychological,  rather  than  economic, 
considerations. 

Old  Age,  Sickness,  and  Death  of  Chief  Wage  Earner 
—  In  at  least  one  very  careful  estimate  of  the  causes 
of  primary  poverty  over  twenty  per  cent  of  the  pov- 
erty was  shown  to  be  due  to  the  age,  sickness,  or  death 


344  AN  INTRODUCTION   TO   ECONOMICS 

of  the  chief  wage  earner.  The  existing  remedies  for 
the  evils  due  to  these  causes,  as  far  as  the  poor  are 
concerned,  may  be  divided  into  three  classes  —  sav- 
ings, private  charity,  and  public  assistance.  As  far 
as  savings  are  concerned,  and  with  these  we  may 
include  such  small  amount  of  insurance  as  is  carried, 
it  can  be  readily  seen  that  there  is  no  possibility  of 
the  amount  being  very  great.  The  amount  earned 
by  those  who  are  near  to  the  verge  of  primary  poverty 
is  so  small  that  any  sum  saved  is  a  direct  reduction 
of  the  amount  necessary  to  provide  the  minimum 
requirements  of  subsistence.  To  devote  any  of  the 
earnings  to  saving  may  easily  mean  the  step  below  the 
border  line.  A  week's  sickness  is  often  enough  to 
cause  the  border  to  be  crossed.  The  earnings,  as  the 
earner  grows  older,  become  less  and  that  fact  alone 
will  cause  the  development  of  primary  poverty  unless 
the  children  are  in  a  position  to  assist.  It  must  be 
noted,  too,  that  the  life  on  the  margin  is  such  as  en- 
courages the  growth  of  disease  and  predisposes  the 
worker  to  that  very  sickness  which  causes  his  ultimate 
poverty.  Again,  the  death  of  the  chief  worker,  when 
it  is  not  due  to  accident  more  or  less  intimately  con- 
nected with  his  work,  is  often  the  result  of  lack  of 
stamina  due  to  malnutrition. 

Savings  are  of  little  assistance.  Private  charity, 
principally  that  of  neighbors  little  better  off,  is  a  mere 
temporary  relief,  and  the  public  assistance  has  often 
been  given  in  a  grudging  spirit  and  with  all  the  appear- 
ance of  charity  —  a  charity  which  a  large  proportion 
of  the  poor  will  refuse  as  long  as  they  are  physically 
able. 


THE   PERSONAL   DISTRIBUTION   OF   WEALTH      345 

Do  these  causes  of  poverty  belong  to  our  first  cate- 
gory, the  maladjustment  of  industry,  or  are  they  due 
to  personal  inefficiency?  It  is  obvious  that  they  are 
intimately  connected  with  the  question  of  low  wages. 
We  can,  therefore,  only  answer  this  question  when  we 
have  considered  that  of  low  wages. 

Unemployment  and  Irregular  Employment  —  The 
amount  of  primary  poverty  due  to  unemployment 
and  irregular  employment  is  variously  estimated. 
That  it  forms  a  very  important  factor,  however,  no 
one  denies.  Irregular  employment  does  not  necessarily 
mean  poverty.  A  barrister  or  a  civil  engineer  often 
works  irregularly,  but  is  not  reduced  to  poverty 
thereby.  Poverty  is  the  result  of  irregular  employ- 
ment at  low  wages.  Unemployment  is  merely  an 
extension  of  the  question  of  irregular  employment. 
Few  workmen  are  permanently  employed,  and  the 
only  essential  difference  between  unemployment  and 
irregular  employment  is  the  tendency  of  the  former 
to  exist  for  longer  periods,  which  follow  on  periods 
of  comparatively  steady  work.  Both,  however,  are 
largely  due  to  industrial  maladjustment.  It  is  true 
that  there  exists  a  class  which  is  called  the  unemploy- 
able. But  whether  this  class  is  not  the  result,  itself,  of 
industrial  maladjustment  is  a  problem  worth  discuss- 
ing. There  is  no  doubt  that,  if  it  is  not  entirely  due  to 
poor  organization  of  industry,  at  least  poor  organiza- 
tion has  a  considerable  amount  to  do  with  it. 

Low  Wages  —  We  now  come  to  the  consideration 
of  the  principal  cause  of  poverty,  low  wages.  We 
have  already  seen  that  the  question  of  wages  is  inti- 
mately connected  with  the  other  causes  of  poverty. 


346  AN  INTRODUCTION   TO   ECONOMICS 

An  English  Justice  of  the  Peace  toward  the  end  of  the 
eighteenth  century  made  a  remark  concerning  the 
wages  paid  by  cotton  manufacturers  of  Manchester, 
which  is  still  applicable.  He  said  that  if  the  cotton 
manufacture  could  not  be  carried  on  unless  starvation 
wages  were  paid,  then  the  cotton  manufacture  had 
no  right  to  exist.  It  has  since  been  proved  conclu- 
sively that  this  industry  can  be  successfully  carried 
on  even  when  much  higher  wages  are  paid.  To  make 
a  dogmatic  assertion  of  the  right  of  a  workman  to  a 
living  wage  may  seem  to  be  encroaching  upon  the 
realm  of  ethics,  but  the  economist  cannot  always 
make  the  distinction  between  his  own  science  and  that 
of  ethics.  Any  industry  which  is  impossible  without 
the  payment  of  low  wages,  has  no  justification.  From 
a  social  point  of  view,  the  industry  exists  to  supply 
a  social  need.  If  the  measure  of  its  social  necessity 
is  so  small  that  the  returns  do  not  justify  a  wage  suffi- 
cient to  cover  the  necessities  of  life  to  those  who  provide 
for  the  needs,  then  the  industry  is  not  of  sufficient 
value  to  warrant  its  continuance. 

Low  wages  are  an  inevitable  source  of  poor  labor 
and  discontented  laborers.  There  is  an  obvious,  but 
erroneous  argument  that  labor  costs  are  synonymous 
with  wage  rates.  This  idea  still  exists  in  spite  of 
the  thousands  of  cases  where  it  has  been  disproved. 
On  the  one  hand  we  have  industrial  leaders  declaim- 
ing against  the  competition  of  foreign  pauper  labor 
and  on  the  other  the  same  individuals  stating  that 
the  American  workman  can  turn  out  much  better  fin- 
ished goods  than  the  foreign  workman  and  several 
times  more  quickly.  It  must  be  realized  that  high 


THE   PERSONAL  DISTRIBUTION   OF  WEALTH      347 

wages  almost  invariably  pay  the  employer,  provided 
his  organization  is  good.  This  question  will  be  con- 
sidered further  in  our  discussion  of  labor  problems. 

Another  effect  of  low  wages  is,  however,  to  depress 
the  condition  of  the  wage  earner  to  such  an  extent 
that  he  cannot  be  efficient.  His  inefficiency  is  often 
directly  or  indirectly  due  to  his  low  wages.  Naturally 
the  low-paid  trades  only  attract  those  who  are  either 
unskilled  or  who  have  failed  at  the  trade  which  they 
know,  and  in  so  far  we  may  say  that  inefficiency  en- 
courages low  wages.  Even  if  that  be  true,  however, 
it  cannot  be  said  that  inefficiency  causes  low  wages. 

And  now  we  come  to  the  final  cause  of  poverty  — 
the  thriftlessness  of  the  poor.  To  describe  thriftless- 
ness  as  a  cause  of  poverty  is  to  put  the  cart  before  the 
horse.  Thriftlessness  is  the  inevitable  result  of  poverty, 
particularly  of  primary  poverty.  The  primary  poor 
have  no  further  to  fall;  they  have,  as  it  seems  to 
them  at  least,  no  chance  to  rise,  and  hence  their  lives 
become  an  example  of  fatalism.  They  live  from  day 
to  day  and  the  present  is  always  with  them.  It  is  the 
immediate  satisfaction  that  is  required  and  the  future 
is  discounted  at  a  heavy  rate.  It  is  said  that  the  poor 
waste  their  substance  in  drink.  Possibly  the  charge 
is  true,  and  we  have  no  wish  to  minimize  the  evils  of 
drink.  But  we  must  at  the  same  time  recognize 
that  very  often  poverty  is  as  much  the  cause  as  the 
consequence  of  drink. 

Sufficient  has  been  said  now  to  show  that  our  main 
conclusion  as  to  the  causes  of  poverty  is  that  poverty 
is  due  in  a  preponderating  measure  to  social  and  in- 
dustrial maladjustment.  But  we  have  yet  to  answer 


348  AN  INTRODUCTION  TO  ECONOMICS 

the  question  why  this  maladjustment  is  allowed  to 
remain.  We  presume  the  belief  that  a  greater  equal- 
ity of  income  would  be  a  benefit  to  society  as  well  as 
to  the  great  bulk  of  the  individuals  who  compose  it. 
Why  is  not  the  equality  attained?  To  answer  this 
question  we  must  consider  the  incentives  to  wealth 
and  to  work. 

The  Incentives  to  Wealth,  i.  The  Will  to  Live  — 
The  fundamental  incentive  to  wealth  is  the  desire 
to  escape  poverty,  which  is  itself  a  desire  to  escape 
death.  Talleyrand,  the  great  French  statesman,  re- 
plied to  an  applicant  for  a  position  who  used  the  old 
phrase,  "a  man  must  live,"  "  I  don't  see  the  necessity." 
This  cynical  utterance  has  been  repeated  with  great 
approval  by  the  would-be  witty  and  by  those  who  are 
themselves  in  a  good  position,  and  who  believe  in 
the  inefficiency  theory  of  the  cause  of  poverty.  As 
a  matter  of  fact,  however,  the  old  expression  is  true. 
A  man  must  live,  if  he  is  to  continue  being  a  man. 
It  is  an  individual  belief  and  society  is  composed  of 
individuals.  Under  present  conditions,  the  possession 
of  wealth  is  the  guarantee  of  life.  Its  lack  is  the  signal 
for  death.  In  a  primitive  society  death  was  always 
near,  but  with  the  growth  of  industry  and  the  gradual 
building  up  of  modern  industrial  organization,  the 
approach  of  death  has  been  postponed.  But  it  has 
not  been  postponed  for  all  alike.  Apart  from  the 
accidents  of  life  and  the  inevitability  of  death,  its 
approach  is  still  determined  by  the  amount  of  wealth 
the  individual  has  obtained.  Hence  the  inevitable 
struggle  for  wealth.  It  is  the  will  to  live  made  con- 
scious and  intellectualized.  The  primitive  savage 


THE   PERSONAL  DISTRIBUTION   OF  WEALTH      349 

indulged  in  no  speculations  as  to  why  he  sought  for 
food,  or  why  he  stored  up  those  possessions  which 
were  of  value  to  him.  Nevertheless,  the  will  to  live  was 
there.  All  that  has  changed  since  that  era  is  the  degree 
of  intelligence  displayed  in  satisfying  the  will  to  live. 
We  have  based  our  society  on  the  individual  possession 
of  wealth,  and  all,  in  greater  or  less  degree,  still  seek 
to  gather  wealth  in  order  to  postpone  the  evil  hour 
when  the  wealth  shall  be  of  no  more  use.  Xot  only 
for  ourselves  do  we  seek  the  wealth,  however.  The 
parent  seeks  to  prevent  the  poverty  of  his  child  and 
tries  to  guarantee  security  against  want  by  increasing 
his  own  struggle  for  wealth.  Security  against  poverty 
is  the  great  stimulus  to  the  search  for  riches. 

2.  The   Acquisitive   Instinct  —  But  the  pursuit  of 
wealth  is  assisted  and  developed  by  the  acquisitive 
instinct.     In  some  cases  the  latter  persists  after  the 
security  against  poverty  has  been  attained.     In  ex- 
treme cases  the  result  is  the  production  of  the  miser,  but 
there   are   many   degrees.     The   habit   of   acquisition 
remains  after  the  original  aim  has  been  satisfied,  and 
the  pursuit  of  wealth  for  wealth's  sake  is  the  result. 

3.  Emulation  —  While  we  are  safe  in  considering 
the  will  to  live  as  the  fundamental  cause  of  the  pursuit 
of  wealth,  it  is  not  the  only  cause.     For,  the  first 
desire    being    satisfied,    others    develop.     The    spirit 
of  emulation  has  a  strong  influence.     We  like  to  do  as 
well  as  our  neighbors.     In  fact  we  go  further;    we 
wish  to  appear  more  prosperous.     Living  in  a  society 
in  which  wealth  is  the  index  to  social  position,  w^e  find 
that  the  desire  for  social  importance  itself  produces 
a  further  incentive  to  the  pursuit  of  wealth.     This  is 


350  AN  INTRODUCTION   TO   ECONOMICS 

evidenced  in  all  ranks  of  society,  but  nowhere  is  it 
more  strongly  developed  than  in  the  wealthy  classes. 
Here  emulation  turns  to  ostentation  and  extravagance-. 
The  pursuit  has  been  so  successful  that  the  problem 
of  the  expenditure  of  the  acquired  wealth  arises.  The 
owner  of  the  wealth  actually  has  to  devise  new  desires 
to  satisfy,  in  order  to  expend  what  he  has  acquired. 

4.  The  Will  to  Power  —  Finally,  we  come  to  an 
incentive  which  is  almost  as  important  as  the  will  to 
live  —  the  desire  for  power.  It  is  not  given  to  all 
to  have  the  dominant  instinct  or  the  ability  to  put 
the  instinct  to  effect.  There  are  those  who  have  little 
desire  to  govern  others,  but,  on  the  other  hand,  there 
are  many  who  constantly  desire  the  power  to  rule 
and  to  control.  Under  modern  conditions  the  power 
to  control  the  actions  of  others  lies  essentially  in  the 
hands  of  those  who  possess  wealth.  Wealth  is  a  means 
of  power  and  hence  those  who  strongly  wish  to  exert 
their  dominant  instinct  must  first  seek  wealth. 

Now  all  these  desires  are  inherent  in  humanity. 
That  they  have  led  to  abuses  and  inequalities  is  un- 
doubted, but  that  does  not  lessen  their  importance. 
Nor  does  it  necessarily  follow  that  the  desires  must 
be  eliminated  before  we  can  secure  the  removal  of 
the  evils  whose  existence  we  admit.  It  has  been 
argued,  however,  that  those  evils  are  the  natural  result 
of  the  desires  and  that  they  are,  therefore,  inevitable. 
But  this  is  by  no  means  true.  It  is  only  true  if  we 
premise  a  society  like  the  present  in  which  wealth  is 
the  insignia  of  power  and  importance.  Now  it  is 
not  true,  as  has  often  been  supposed,  that  if  the  posses- 
sion of  undue  wealth  were  not  permitted,  the  stimulus 


THE   PERSONAL  DISTRIBUTION   OF  WEALTH      351 

to  exertion,  whether  of  hand  or  brain,  would  be  lost. 
A  brief  analysis  of  the  incentives  to  work  will  serve 
to  remove  that  idea. 

The  Incentives  to  Work  —  It  is  true,  of  course, 
that  the  incentives  to  industry  sometimes  coincide  with 
the  incentives  to  wealth.  This  is  particularly  so  in 
regard  to  the  first  of  those  incentives  —  the  will  to 
live.  But,  having  granted  that  primary  similarity, 
we  must  also  admit  that  work  is  a  human  necessity. 
The  expression  "  the  right  to  work  "  has  long  been  a 
commonplace  among  working  men,  but  the  sense  in 
which  they  use  it  is  that  of  the  right  to  gain  a 
living  through  work.  That  is  not  the  sense  in  which 
we  speak  of  work  as  a  human  necessity.  The  desire 
for  activity  is  elemental,  and  idleness  is  only  pleasant 
as  a  relief  from  activity.  Even  a  schoolboy  will  tire 
of  too  long  a  vacation  and  it  will  be  a  relief  to  get  back 
to  the  discipline  and  industry  of  the  schoolroom.  We 
overestimate  the  importance  of  idleness  because  we 
have  too  little  of  it.  To  the  man  whose  life  is  a  con- 
stant round  of  more  or  less  uncongenial  work,  the  idle 
period  seems  like  a  brief  taste  of  heaven.  But  even 
those  who  have  the  opportunity  to  be  idle  constantly 
are  nevertheless  nearly  always  seeking  for  some  outlet 
for  their  energies.  It  is  true  that  they  may  find  that 
outlet  in  sport  or  in  some  of  the  more  inane  activities 
of  the  idle  rich,  but  not  necessarily  so.  These  follies 
may  show  a  lack  of  intelligence,  but  they  do  not  show 
that  work  is  distasteful.  They  are  merely  an  echo 
of  the  general  feeling  that  work  is  unpleasant,  a  feeling 
generated  by  the  fact  that  most  of  us  have  too  much 
of  it,  and  a  great  deal  of  it  is  needlessly  unpleasant. 


352  AN  INTRODUCTION   TO   ECONOMICS 

"  The  Joy  of  Working"  —  Again,  much  of  the 
pleasure  of  work  is  lost  at  present  through  the  fact 
that  so  much  work  is  poor.  There  is  no  pleasure 
in  doing  poor  work,  but,  on  the  contrary,  there  is  a 
great  delight  in  doing  good  work.  Compare  the 
attitude  of  the  workman  in  a  shoddy  furniture  factory 
where  everything  is  sacrificed  to  speed  and  cheapness, 
with  that  of  the  workman  who  is  doing  a  high-class 
job  with  the  best  materials  and  with  sufficient  time 
allowed  to  produce  his  best  work.  Listen  to  the 
conversation  of  a  couple  of  engineers  off  duty.  Almost 
invariably  it  will  turn  on  the  work  they  have  been 
doing.  There  is  contemptuous  scorn  for  a  set  of 
badly  constructed  and  erratic  engines,  but  there  is  also 
the  almost  paternal  pride  in  a  good  set.  Kipling's 
"McAndrews*  Hymn  "  is  not  all  imagination.  The  feel- 
ing exists  to  a  greater  or  less  degree  in  all  of  us.  The 
London  bus  driver  spends  his  holiday  riding  on  an- 
other man's  bus. 

Society  has,  up  to  the  present,  made  too  little  use  of 
the  spirit  which  animates  the  man  engaged  in  good 
work.  Too  much  is  sacrificed  to  a  totally  unnecessary 
cheapness,  and  to  overexertion  on  the  part  of  the 
worker.  Even  the  enthusiast  will  tire  if  the  subject 
of  his  enthusiasm  is  too  much  with  him. 

We  may  be  quite  sure,  then,  that  even  if  the  incen- 
tives to  wealth  did  not  exist,  work  would  go  on,  and 
very  likely  much  better  work  through  the  stimulus 
of  the  pride  in  the  work  done,  and  the  joy  of  working. 

The  Creative  Instinct  —  There  is  a  further  point 
which  must  not  be  omitted,  and  that  is  the  effect 
of  the  creative  instinct.  If  there  is  one  form  of  work- 


THE    PERSONAL   DISTRIBUTION    OF   WEALTH      353 

ing  which  is  not  influenced  by  the  desire  to  accumulate 
wealth,  it  is  the  creative  form.  The  artist  produces 
his  pot  boilers  to  earn  a  living,  but  his  real  work,  the 
work  on  which  he  spends  most  of  his  time  and  all  of 
his  best  efforts,  is  done  in  the  joy  of  a  new  creation, 
an  expression  of  himself  which  is  independent  of  his 
social  or  financial  position.  And  by  the  artist,  we  do 
not  necessarily  mean  only  the  painter,  sculptor,  or 
musician.  The  creative  instinct  is  in  all  of  us  to  a 
greater  or  less  degree.  It  is  the  driving  force  of  the 
inventor,  but  it  is  also  the  stimulus  of  the  craftsman 
no  matter  what  his  craft.  It  is  not  necessary  even 
that  the  craftsman  should  produce  the  whole  of  the 
finished  article.  The  pride  in  the  working  may  only 
extend  to  his  particular  product,  but  it  is  there. 

The  Organizing  Instinct  —  The  organizing  instinct 
is  only  one  aspect  of  the  creative.  There  are  men  who 
are  born  to  create  order  out  of  chaos  and  whose  special 
pride  it  is  to  do  so.  These  are  the  born  organizers 
and  it  is  waste  of  social  material  to  lose  or  to  abuse 
their  powers.  There  can  be  little  doubt  that  it  is 
not  entirely  the  rewards  of  the  organizer  which  induce 
him  to  work.  Provided  the  initial  security  against 
poverty  is  attained,  then  he  would  do  the  work  of  the 
character  for  which  he  is  best  suited  rather  than  not 
work  at  all,  or  work  at  some  less  congenial  but  more 
profitable  occupation. 

The  Dominating  Instinct  —  The  same  is  true  of 
the  dominating  instinct.  The  men  who  possess  in 
the  highest  degree  the  will  to  power  and  who  have 
the  requisite  ability  to  exercise  that  power  will  inevit- 
ably secure  the  controlling  positions.  At  present  they 


354  AN  INTRODUCTION   TO   ECONOMICS 

do  so  by  attaining  wealth,  since  by  the  possession  of 
wealth  alone  are  they  able  to  realize  their  power.  It 
is  obvious,  however,  that  many  of  them  have  far 
more  wealth  than  they  can  possibly  use  and  indeed 
sometimes  more  than  they  desire,  but  as  power  depends 
upon  wealth  they  seek  more  and  more.  The  present 
situation  is  unfortunate  in  that  it  often  gives  power 
into  the  hands  of  those  who  have  merely  the  money- 
making  gift,  which  is  not  by  any  means  the  same  as 
the  creative  or  organizing  power.  If  the  domination  of 
those  who  are  not  really  the  possessors  of  the  directive 
and  controlling  ability  were  eliminated  from  society 
by  the  removal  of  the  wealth  stimulus,  society  would 
be  an  infinite  gainer. 

In  this  chapter  we  have  tried  to  show  that  the  great 
inequalities  of  the  personal  distribution  of  wealth  are 
not  necessary  to  the  continuance  of  industrial  society. 
At  present  wealth  is  the  one  means  of  satisfying  some 
of  the  strongest  of  human  instincts.  There  is  little 
doubt,  however,  that  these  instincts  would  still  be  in 
operation  were  the  wealth  stimulus  removed.  The 
feeling  that  gross  inequalities  of  wealth  possession  in- 
volving lavish  and  wasteful  expenditure  on  one  hand 
and  semistarvation  on  the  other,  are  a  disgrace  to  civ- 
ilization, is  growing.  The  remedies  for  the  existing 
conditions  must  remain  for  discussion  in  a  later  chapter. 


CHAPTER  XXVI 
THE   REMUNERATION   OF  LABOR 

The  Meaning  of  the  Word  Labor  —  Like  so  many 
other  words  which  are  used  in  common  speech,  the 
meaning  of  the  word  labor  varies  according  to  £ir- 
cumstances.  In  the  most  accurate  sense  the  word 
signifies  the  human  effort  in  the  production  of  utilities. 
This  is  a  much  wider  meaning  than  is  commonly  given 
to  the  word  labor.  In  ordinary  speech  it  usually 
means  manual  effort  only.  When  we  speak  of  a 
laborer  we  naturally  understand  a  person  who  works 
with  his  hands.  No  one  thinks  of  the  general  man- 
ager of  an  insurance  company  as  a  laborer ;  nor  is  the 
term  usually  applied  to  a  consulting  engineer  or  a 
doctor.  Yet  each  of  these  is  using  his  effort  to  produce 
utilities.  In  the  distribution  of  the  national  dividend 
(i.e.,  the  total  amount  produced  within  the  nation 
in  a  definite  period  of  time,  say  a  year)  labor  must  have 
its  share  as  well  as  capital,  rent,  interest,  and  profits. 
The  management  of  a  business  is  just  as  much  labor, 
in  the  true  sense,  as  the  work  of  the  mason  and  car- 
penter. 

There  is  a  strong  tendency  nowadays  for  the  manual 
workers  to  realize  their  ^cppmunity  of  interest  with 
those  who  work  by  brain,  instead  of  by  hand,  but 
nevertheless,  there  is  much  justification  for  the  common 
meaning  attached  to  the  term.  It  has  been  recognized 
355 


356  AN  INTRODUCTION   TO   ECONOMICS 

that  the  manual  worker  is  at  the  bottom  of  the  social 
scale  as  well  as  of  the  economic,  and  the  problem  of 
keeping  him  contented  —  which  is  the  aim  of  one  class, 
or  of  providing  him  with  an  adequate  share  of  the 
world's  products  and  the  means  of  a  full  development 
of  his  capacities,  has  laid  such  a  stress  on  his  particular 
form  of  labor  that  it  is  perfectly  natural  to  restrict 
the  term  to  that  form.  The  fuller  meaning,  as  we 
shall  see  in  a  later  chapter,  is  of  great  importance  in 
disjcussing  modern  problems,  but  in  the  meantime 
we  shall  consider  labor  as  meaning  that  form  of  work 
which  deals  mainly  with  physical  effort  and  leave  out 
of  consideration  the  purely  mental  effort. 

Labor's  Part  in  Production  —  It  is  customary  to 
speak  of  capital  as  if  it  were  a  separate  and  almost 
human  entity.  Capital  is,  however,  merely  a  form 
of  a  product.  By  itself  it  is  not  a  producer.  Capital 
is  a  tool,  and  the  tool  is  useless  without  the  hand  to 
wield  it.  The  human  effort  is  the  prime  moving 
force  and  without  this  all  the  capital  in  the  world  is 
absolutely  useless.  At  the  same  time,  capital,  while  it 
is  undoubtedly  the  result  of  labor,  is  the  result  of 
past  labor  —  labor  which  has  been  employed  in  the 
producing  of  a  means  to  an  end.  Labor  is  not  exactly 
useless  without  capital;  it  is  inefficient.  The  ineffi- 
ciency, however,  at  any  rate  as  far  as  the  satisfaction 
of  the  needs  of  the  modern  world  is  concerned,  amounts 
practically  to  uselessness. 

Without  the  stored-up  labor  in  capital  modern  pro- 
duction would  be  impossible.  Now  the  facts  are  that 
labor  is  separated  from  the  ownership  of  capital. 
This  is  not  necessarily  so.  Of  course  a  man  may  own 


THE   REMUNERATION   OF   LABOR  357 

all  the  tools  and  machinery  which  are  necessary  for 
his  own  particular  occupation.  A  dentist  may,  and 
usually  does,  own  his  forceps,  drills,  and  other  apparatus. 
But  there  is  nothing  inherently  necessary  in  labor 
owning  its  capital.  The  ownership  is  usually  vested  in 
some  person  or  group  of  persons  who  do  not  themselves 
perform  the  labor  which  makes  use  of  that  capital. 

Hence  it  is  worth  while,  in  practice,  to  consider  the 
actual  share  in  production  which  is  due  to  labor, 
apart  from  the  share  due  to  capital. 

It  is  quite  impossible  to  apportion  the  share  due  to 
labor  in  any  scientific  way.  In  practice  one  is  just 
as  necessary  as  the  other,  and  in  different  occupations 
the  ratio  of  capital  to  labor  varies  within  very  wide 
limits.  In  an  industry  like  the  manufacture  of  cotton 
an  enormous  amount  of  capital  is  required.  In  simple 
agriculture  the  proportion  of  capital  (using  the  term 
principally  as  applying  to  fixed  capital)  is  compar- 
atively small. 

Labor  as  a  Commodity  —  Labor,  however,  is  not 
the  inanimate  entity  that  capital  is.  Labor  presup- 
poses the  laborer.  This  fact  is  of  great  importance 
in  our  study.  There  was  a  tendency  not  so  very  long 
ago  to  speak  of  labor  in  exactly  the  same  terms  as  we 
speak  of  steel  manufactures  or  of  wheat.  It  was 
regarded  as  a  commodity  that  is  bought  and  sold  and 
subject  to  all  the  laws  of  exchange  which  we  have 
studied  in  previous  chapters.  Hence  we  still  use  such 
expressions  as  labor  market,  supply  and  demand  for 
labor,  and  so  forth.  The  laws  governing  the  remu- 
neration of  labor  have  been  to  a  very  large  extent 
based  upon  the  treatment  of  labor  as  if  it  were  a  form 


358  AN  INTRODUCTION   TO   ECONOMICS 

of  goods.  We  shall  have  to  examine  some  of  these 
laws,  but  before  we  do  so,  it  is  necessary  to  under- 
stand fully  that  labor  cannot  be  treated  exactly  as  a 
commodity. 

The  problem  with  which  we  set  out,  the  finding  of 
the  best  means  of  utilizing  the  economic  resources 
of  the  world,  did  not  imply  that  the  solution  was 
reached  when  one  or  two,  or  even  a  large  group  of 
individuals  received  all  that  their  demands  required. 
Rather  it  meant  that  all  the  individuals  in  the  world 
should  be  satisfied  as  far  as  the  resources  of  the  earth 
made  possible.  To  treat  the  laborer,  therefore,  as 
merely  the  possessor  of  a  certain  quality  which  is 
necessary  to  the  welfare  of  his  fellows,  although  inci- 
dentally necessary  to  himself  also,  is  unsound.  It  is 
to  follow  out  the  Greek  idea  that  culture  was  the 
prerogative  of  the  wealthy,  or  at  any  rate,  of  those  who 
were  sufficiently  possessed  of  the  world's  goods  to  be 
free  from  the  necessity  of  working  for  a  living.  It 
is  to  accept  Nietzsche's  idea  that  only  the  favored  few 
are  capable  of  the  highest  development  and  that  all 
others  are  merely  means  to  the  securing  of  that  high- 
est development.  In  simple  words,  the  laborer,  if  labor 
is  considered  to  be  a  commodity,  is  regarded  in  exactly 
the  same  manner  as  one  regards  horses  and  cattle. 

Now  while  we  do  not  argue  that  all  are  capable  of 
the  same  heights  of  development,  nevertheless,  we 
assume  that  each  is  entitled  to  the  privilege  of  securing 
the  highest  development  of  which  he  is  capable,  and 
that  the  welfare  of  the  race  is  not  determined  by  the 
attainments  of  the  few,  but  rather  by  the  high  average 
of  culture  attained  by  all  its  members. 


THE   REMUNERATION   OF   LABOR  359 

Wage  Theories,  i.  The  Iron  Law;  — With  this 
preface,  then,  we  can  now  turn  to  the  consideration 
of  some  of  the  theories  suggested  to  explain  the  remu- 
neration of  labor.  It  has  been  assumed  that  labor 
is  subject  to  the  laws  of  supply  and  demand.  The 
greater  the  supply  of  labor,  coupled  with  a  constant 
or  decreasing  demand,  the  smaller  the  share  which 
the  individual  laborer  could  obtain.  Given  a  certain 
proportion  of  laborers  to  a  certain  demand,  it  followed 
that  there  was  a  definite  limit  to  the  average  share  of 
the  product  received  by  the  laborers.  Let  us  take 
an  example.  Suppose  there  is  a  demand  for  fifty 
laborers  and  a  production  which  warrants  a  total  pay- 
ment to  labor  of  $1000.  The  amount  that  each  laborer 
can  receive  is  $20.  Of  course  some  may  receive  more 
than  this  amount,  but  if  they  do,  others  must  receive 
less.  Now  suppose  that,  without  increasing  the 
sum  available  to  pay  the  laborers,  that  is,  without 
increasing  the  demand  for  labor,  the  number  of  laborers 
is  increased  to  one  hundred.  Obviously  the  amount 
which  each  can  receive  on  the  average  is  only  $10. 

On  the  other  hand,  should  the  demand  for  laborers 
increase  and  the  number  remain  constant,  the  indi- 
vidual laborer's  share  would  increase.  Things  remain 
the  same  when  the  demand  for  labor  keeps  pace  with 
the  supply.  The  question  then  arises,  what  is  the 
cause  of  the  demand  for  labor.  Labor  in  itself  is 
not  desired  —  it  is  merely  a  means  to  an  end.  It  is 
the  product  of  labor  which  is  required.  But  the  product 
of  labor  is  limited  by  the  earth's  resources,  coupled 
with  our  knowledge  of  the  means  to  make  use  of  them. 
The  supply  of  labor  is  determined  largely  by  the  increase 


360  AN  INTRODUCTION   TO   ECONOMICS 

or  decrease  of  the  population.  At  the  time  in  which 
the  theory  we  are  now  discussing  was  most  strongly 
held,  the  food  production  of  the  world  was  working 
under  the  law  of  decreasing  returns.  Population, 
however,  tended  to  increase  at  a  faster  rate  than  food 
production.  Hence  a  time  arrived  when  the  means  of 
feeding  the  increased  population  was  insufficient  for 
its  needs.  Some  must  starve.  The  starving,  however, 
would  struggle  to  obtain  as  much  as  possible,  and 
would  offer  themselves  for  wages  which  would  suffice 
to  keep  body  and  soul  together.  The  tendency, 
therefore,  was  to  force  the  wages  down  to  the  bottom 
level  of  subsistence.  If  the  laborer  received  less  than 
sufficient  to  feed  him,  he  died  and  so  starvation  reduced 
the  population  down  to  the  level  at  which  there  was 
sufficient  food  to  go  around,  but  only  sufficient. 

Any  improvement  in  the  means  of  obtaining  an 
increased  supply  of  food  was,  it  was  assumed,  immedi- 
ately followed  by  an  increase  in  the  population.  Hence 
wages  tended  to  fall,  by  this  very  pressure  of  popu- 
lation on  the  means  of  subsistence,  to  the  level  at 
which  subsistence  was  just  possible. 

We  have  stated  this  argument  as  if  it  actually 
represented  the  facts.  At  the  beginning  of  the  nine- 
teenth century,  in  England,  at  any  rate,  where  the 
theory  was  developed,  the  facts  did  seem  to  justify 
the  conclusion.  But  before  the  century  was  far 
advanced,  the  facts  changed.  Wages  were  not  forced 
to  the  level  of  subsistence.  The  "  iron  law,"  as  it  has 
been  called,  was  broken,  and  therefore,  invalid. 

The  theory  was  not  quite  abandoned,  however. 
It  was  mitigated  by  changing  the  term  level  of  sub- 


THE   REMUNERATION   OF   LABOR  361 

sistence  to  the  words  standard  of  living.  The  new  law 
was  expressed  somewhat  as  follows.  Wages  tend  to 
fall  to  the  level  which  will  provide  for  the  subsistence 
of  the  laborer  at  the  standard  of  living  to  which  he 
is  accustomed.  As  a  Socialist  writer  put  it,  "  If  the 
working  man  believes  that  bottled  beer  and  chops 
are  necessary  for  subsistence,  his  wages  will  be  suffi- 
cient to  provide  him  with  bottled  beer  and  chops." 

This,  however,  did  not  affect  the  principle  of  the 
argument.  All  that  was  changed  was  the  meaning 
given  to  level  of  subsistence.  Under  this  theory, 
wages  are  still  dependent  upon  population.  From 
the  logic  of  the  argument  there  is  no  escape.  If  we 
admit  the  premises,  we  must  accept  the  conclusion. 
But  are  the  premises  correct?  It  would  seem  from 
experience  that  they  are  not.  In  the  first  place, 
when  the  theory  was  first  formulated,  the  conditions 
of  the  time  lent  a  strong  color  to  the  argument  by 
which  it  was  supported.  The  population  was  increas- 
ing by  leaps  and  bounds.  At  the  same  time  the  pro- 
duction of  food  was,  although  increasing,  increasing 
at  a  much  slower  rate.  There  was  no  suggestion 
that  the  old  countries  could  draw  to  such  an  amazing 
extent  as  is  now  the  case,  on  the  New  World  for  their 
food  supplies.  Hence  it  appeared  as  if  the  facts  actually 
justified  the  theory.  But  as  the  New  World  began  to 
be  drawn  upon  for  food  supplies  —  as  the  prairies 
of  America  were  gradually  and  increasingly  cultivated, 
and  as  the  facilities  for  sea  transportation  improved, 
the  food  difficulty  seemed  to  be  solved.  Nor  has 
population  increased  to  the  extent  that  was  anticipated. 
There  seems  to  be  a  strong  tendency  for  the  increase 


362  AN  INTRODUCTION   TO   ECONOMICS 

of  population  to  be  less  under  prosperity  of  the  indi- 
vidual rather  than  greater.  The  larger  families  are 
seen  in  the  poorer  portions  of  the  population,  not  in 
the  more  well-to-do. 

The  theory  must,  therefore,  be  abandoned.  We 
know  that  there  is  sufficient  knowledge  of  the  earth's 
resources,  and  sufficient  resources  to  feed  adequately 
all  the  population  of  the  world.  The  problem  is 
rather  to  discover  how  the  knowledge  may  be  made 
use  of  to  the  best  advantage,  and  how  the  product 
may  be  more  equitably  distributed.  Labor  has  come 
to  demand  something  more  than  a  mere  subsistence 
wage.  It  demands  the  "  living  wage,"  and  the  inter- 
pretation of  the  word  living  is  becoming  more  generous 
with  each  advance  in  the  general  standard.  The 
modern  demand  of  the  laborer  is  that  he  should  have 
sufficient  share  of  the  productions  of  the  world  to 
develop  himself  to  the  fullest  extent ;  that  his  labor 
should  not  fill  all  the  hours  of  waking,  but  that  he 
should  have  sufficient  leisure  to  make  life  worth  living. 
This  demand  is  a  worthy  one.  Can  it  be  met  ?  That 
is  a  problem  which  must  be  discussed  in  a  later  chap- 
ter. Meanwhile  we  must  turn  to  another  aspect  of 
the  problem  of  the  remuneration  of  labor. 

Money  and  Real  Wages  —  It  is  a  commonplace 
to  say  that  the  amount  of  money  a  man  earns  is  no 
satisfactory  indication  of  the  remuneration  of  his 
toil.  It  may  quite  easily  happen  that  wages  tend 
to  increase  steadily  as  far  as  money  amounts  are 
concerned,  but  that  the  recipients  become  just  as 
steadily  worse  off.  Suppose,  for  example,  that  a  man 
earns  $100  a  month.  It  would  appear  that  a  rise  of 


THE   REMUNERATION   OF   LABOR  363 

$10  a  month  would  improve  his  position  exactly  ten 
per  cent.  But  suppose  that,  at  the  same  time  prices 
advance  twenty  per  cent.  In  this  case  the  $110  at 
the  new  price  buys  only  about  ninety-two  per  cent  of 
the  goods  that  the  $100  bought  at  the  old  price.  The 
wages  of  the  workmen  have  therefore  actually  fallen  in 
value,  although  nominally  they  have  risen. 

As  we  have  said,  this  is  a  commonplace,  but  it  is  just 
one  of  those  commonplaces  which  are  easily  over- 
looked. We  become  so  accustomed  to  dealing  in 
terms  of  money  that  we  are  inclined  to  overlook  the 
fluctuations  in  the  value  of  money.  In  any  discussion 
of  increases  and  decreases  in  wages,  we  must  be  care- 
ful to  think  of  real  wages,  that  is,  the  purchasing  power 
of  the  wages,  rather  than  the  sum  of  money  received 
in  a  certain  time.  To  make  the  matter  plainer  still, 
let  us  suppose  that  a  man  is  in  receipt  of  sufficient 
wages  to  purchase  all  he  requires  but  not  sufficient 
to  save  anything.  Now  suppose  his  wages  are  in- 
creased, in  terms  of  money,  ten  per  cent.  If  prices 
remain  stationary  he  should  be  able,  without  in- 
creasing his  expenditure,  to  save  that  ten  per  cent 
increase.  Should  prices  have  risen,  however,  to  such 
an  extent  that  he  cannot  save  at  all,  but  can  just 
maintain  his  old  habit  of  life,  neither  increasing  the 
amount  of  goods  he  purchases  nor  decreasing  them, 
then  it  is  obvious  that  he  is  in  reality  only  earn- 
ing as  much  as  before.  And  should  he  be  forced,  by 
the  rise  of  prices,  to  give  up  some  of  the  things  he 
used  to  buy,  his  actual,  or  real  wages  have  fallen, 
in  spite  of  the  fact  that  he  receives  ten  per  cent  more 
money. 


364  AN  INTRODUCTION   TO   ECONOMICS 

The  Method  of  Payment  —  Of  almost  as  much 
importance  to  the  wage  earner  as  the  amount  of  his 
earnings  is  the  manner  in  which  he  is  paid.  We  may 
distinguish  four  different  methods. 

i .  Time  Wages  —  The  commonest  form  of  all 
wage  payments  is  the  payment  by  time.  All  salaried 
workers  are  paid  not  according  to  how  much  they  do, 
but  according  to  the  time  they  spend  in  doing  it. 
If  two  bookkeepers  are  paid  a  salary  of  $150  a  month 
each,  no  estimate  of  the  amount  of  ledger  work,  post- 
ing, and  checking  is  considered  in  making  the  pay- 
ments. It  is  assumed  that  each  is  doing  the  normal 
amount  of  which  he  is  capable.  If  he  does  not  do  so, 
in  all  probability  he  will  soon  be  seeking  another  job. 
Of  the  two  one  may  be  a  much  quicker  man  than  the 
other.  This  does  not  affect  his  wages.  He  is  paid 
so  much  for  a  month  of  his  effort. 

Again  a  workman  is  paid  sixty  cents  an  hour  for  his 
work.  Two  workmen  at  the  same  rate  of  pay  may 
produce  totally  different  amounts  of  finished  work. 
One  may  be  twice  as  quick  as  the  other  and  if  he  be  as 
accurate,  he  is  producing  twice  the  amount  for  the 
same  number  of  cents.  In  time  payments,  a  certain 
average  of  work  is  presumed,  and  the  rate  of  pay  is 
determined  largely  according  to  the  standard  of  liv- 
ing. That  is  to  say,  if  the  general  standard  of  living 
for  a  particular  class  of  workman  requires  an  expendi- 
ture of  say,  $100  a  month,  the  time  wages  will  be 
such  as,  on  the  whole,  to  provide  an  income  of  $100 
a  month  to  the  workman.  Now  in  all  the  group 
earning  this  time  rate,  there  will  be  variations  be- 
tween extreme  efficiency  and  extreme  inefficiency. 


THE    REMUNERATION   OF   LABOR  365 

The  great  bulk,  however,  will  tend  to  average  their 
production. 

There  is  little  stimulus  to  great  exertion  in  a  time 
rate.  Nevertheless  there  are  great  advantages  in 
this  kind  of  payment.  In  the  first  place,  for  many 
kinds  of  work  it  is  impossible  to  pay  in  any  other  man- 
ner. Take,  for  instance,  the  bulk  of  clerical  work. 
There  would  be  a  very  great  difficulty  in  paying 
stenographers  on  any  other  basis  than  time  rates. 
A  business  man  must  have  his  stenographer  there  all 
the  time.  At  times  she  will  be  busy,  at  other  times 
idle.  The  number  of  letters  written  one  day  will  not 
be  the  same  another,  and  so  on.  The  employer  de- 
mands a  certain  amount  of  effort.  If  he  thinks  that 
his  staff  has  too  many  idle  periods,  he  decreases  the 
staff,  so  that,  on  the  average,  each  does  a  day's  work. 

Again  suppose  it  were  suggested  to  pay  laborers  so 
much  a  cubic  foot  of  earth  removed  in  an  excavation. 
Some  workmen  might  do  all  their  work  in  soft  earth, 
and  so  be  able  to  remove  many  cubic  feet.  Others, 
with  an  equal  expenditure  of  effort,  working  in  hard 
or  rocky  ground,  would  not  be  able  to  do  nearly  so 
well.  Now  as  it  is  quite  possible  that  the  strata 
through  which  the  laborers  are  digging  vary  with  every 
foot  they  dig,  it  is  impossible  to  pay  them  on  any 
other  basis  than  a  rate  for  a  period  of  time,  and  it  will 
be  the  duty  of  the  foreman  to  see  that  each  exercises 
his  fair  share  of  effort. 

2.  Piece  Wages  —  Another  method  is  to  pay,  not 
according  to  the  time  spent,  but  according  to  the 
amount  produced.  There  are  many  industries  in 
which  this  is  the  usual  method.  Take  the  potteries, 


366  AN  INTRODUCTION   TO   ECONOMICS 

for  instance.  Here  there  is  a  long  schedule  of  prices 
to  be  paid  workmen  for  performing  certain  pieces 
of  work.  So  many  cents  a  plate  of  a  certain  size, 
or  a  cup  or  dish,  or  whatever  they  may  be  producing. 
Riveters  in  shipyards  are  sometimes  paid  so  much 
a  rivet  driven,  and  again  sometimes  so  many  cents 
an  hour. 

The  piece-rate  method  has  the  advantage  of  allow- 
ing the  highly  skilled  or  unusually  energetic  the  power 
to  reap  the  advantage  of  their  skill  or  energy  in  the 
shape  of  greater  earnings.  On  the  other  hand,  the 
weaker  or  less  skillful  receive  less.  It  is  objected, 
however,  that  rates  tend  to  be  decided  upon  the  work 
done  by  the  men  of  highest  skill.  The  earnings  of 
a  highly  skilled  man,  coupled  with  the  average  amount 
necessary  to  maintain  him  in  the  standard  of  life  to 
which  he  is  accustomed,  form  the  basis  of  the  piece 
rate.  As  the  highly  skilled  are  the  minority,  the  ma- 
jority must  either  work  longer  hours,  or  else  suffer 
in  decreased  earnings. 

It  is  sometimes  found,  upon  the  introduction  of 
piece  rates,  that  the  production  is  very  much  greater 
than  was  the  case  when  time  wages  were  paid.  Hence 
the  actual  amounts  received  by  the  workmen  become 
much  greater  than  formerly.  Whenever  this  is  the 
case,  it  almost  invariably  occurs  that  there  is  a  cut 
in  the  rates.  The  cut  tends  to  bring  wages  back  to 
the  amount  earned  under  the  time-rate  system.  This 
is  partly  the  reason  why  many  trade  unions  object  to 
the  introduction  of  piece  payments.  They  claim  that 
all  that  happens  is  an  increase  in  the  amount  of  work 
done,  without  a  corresponding  increase  in  the  pay. 


THE   REMUNERATION   OF   LABOR  367 

On  the  other  hand,  it  sometimes  occurs  that  the  men 
protest  against  the  introduction  of  time  rates.  Here 
it  is  claimed  that  by  speeding-up  machinery,  the  work- 
man produces  more  work,  but  reaps  no  benefit  from 
his  increased  production. 

It  is  claimed  on  the  whole  for  piece  rates  that  they 
tend  to  increase  production.  Against  them  it  is 
argued  that  the  workman  is  liable  to  undue  pressure 
in  order  to  earn  the  wage  which  he  regards  as  necessary. 
The  time  wage  is  blamed  for  keeping  production 
at  a  minimum,  while  those  who  favor  it  often  say 
that  it  prevents  the  average  man  from  being  imposed 
upon. 

The  truth  is  that  it  is  impossible  to  say  that  either 
is  bad  or  good  in  itself.  The  case  of  each  individual 
occupation  must  be  settled  by  itself. 

3.  The  Bonus  Systems  —  Many  attempts  have  been 
made  to  combine  the  two  systems  so  as  to  get  the  best 
out  of  each  and  to  eliminate  the  evils  of  both.  One 
system  is  to  pay  all  men,  no  matter  how  much  their 
production,  a  standard  rate.  By  an  investigation 
into  the  average  time  taken  in  the  past  for  a  particular 
job,  however,  a  standard  time  for  a  piece  of  work  is 
set.  Any  workman  who  passes  that  standard  receives 
an  extra  payment  in  the  form  of  a  bonus  for  his  increased 
production.  In  this  way,  both  time  and  piece  rates 
are  combined.  There  is  an  infinite  variety  of  bonus 
systems,  however,  and  that  indicated  here  is  merely 
one  of  the  simplest.  It  is  worth  while,  however,  to 
outline  one  of  the  schemes  which  has  been  criticized 
very  severely  and  also  highly  praised.  In  this  system, 
instead  of  merely  averaging  from  past  experience  to 


368  AN   INTRODUCTION   TO   ECONOMICS 

find  the  time  in  which  a  job  ought  to  be  done,  a  careful 
scientific  investigation  is  carried  out  to  see  which  is 
the  best  way  to  do  it.  The  best  arrangement  of  the 
machinery  is  first  considered.  Then  a  skilled  work- 
man is  set  to  perform  the  task,  every  movement  he 
makes  being  noted,  and  the  time  taken  recorded.  By 
a  study  of  his  actual  movements  all  waste  motions  are 
seen.  These  are  eliminated  and  the  workman  again 
set  to  perform  the  task.  When  it  is  seen  that  every 
motion  is  essential,  and  there  is  no  waste,  the  final 
time  is  recorded. 

As  it  is  obvious  that  the  time  taken  by  a  skilled 
workman  under  these  conditions  is  hardly  the  same  as 
the  time  taken  by  the  average  man,  a  deduction  is 
made  from  the  amount  of  production  required  in  the 
standard  time,  say  twenty  per  cent,  or  even,  in  some 
cases,  fifty  per  cent.  The  time  thus  arrived  at  is 
the  standard  for  this  job.  Then  each  workman  is 
taught  the  method  of  production  arrived  at  by  this 
investigation.  He  is  paid  on  a  time  basis  as  a  mini- 
mum, but  he  receives  a  bonus  when  he  reaches  the 
standard  time,  and  another  bonus  when  he  passes  it. 

There  is  no  doubt  as  to  the  success  of  this  system 
from  the  point  of  view  of  production.  There  have 
been  most  wonderful  increases  made  by  its  means. 
The  effect  upon  the  workman,  however,  is  not  so 
satisfactory.  There  is  good  reason  to  believe  that 
the  increased  work  is  not  obtained  without  a  certain 
increase  in  the  effort.  The  workman  becomes  rather 
a  wonderful  machine  than  a  human  being.  If  the 
hours  of  labor  are  appreciably  shortened  so  as  to  offset 
the  greater  intensity  of  effort,  no  harm  may  be  done, 


THE    REMUNERATION   OF   LABOR  369 

but  if  the  system  is  adopted  without  change  in  the 
hours  worked,  there  can  be  little  doubt  that  a  great 
deal  of  harm  is  done. 

4.  Profit  Sharing  —  The  final  method  of  payment 
is  to  supplement  the  wages  by  allowing  the  workers 
a  share  in  the  profits.  This  method,  however,  will 
require  more  discussion  than  we  can  give  space  to  in 
the  present  chapter.  It  will  be  dealt  with  later  on 
and  is  here  only  mentioned  in  order  to  complete  the 
account  of  methods  of  wage  payment. 


CHAPTER  XXVII 

THE    ORGANIZATION   OF  LABOR 

The  Origin  of  Labor  Organizations  —  There  is  a 
common  but  erroneous  belief  that  trade  unions  have 
their  origin  in  the  old  trade  gilds  or  craft  gilds.  This 
is  not  the  case.  The  craft  gild  was  an  organization 
quite  distinct  in  its  aim  from  the  trade  union.  It  was 
designed  to  include  every  one  in  the  industry,  whether 
craft-master,  journeyman,  or  apprentice;  it  regarded 
the  craft  as  a  unity.  The  trade  union,  on  the  other 
hand,  is  an  organization  definitely  based  upon  the  belief 
that  the  journeymen,  the  common  workers,  cannot 
protect  themselves  against  the  employers  unless  they 
act  as  a  body.  The  origin  of  modern  labor  organiza- 
tion lies  in  the  realization  of  an  antagonism  between 
the  laborer  and  the  capitalist.  Although  we  can 
trace  the  beginnings  of  trade  unionism  to  periods  much 
earlier  than  the  end  of  the  eighteenth  century,  it  was 
the  conditions  resultant  from  the  chaos  of  the  industrial 
revolution  which  brought  about  the  great  combina- 
tions that  have  grown  to  be  of  such  importance  at 
the  present  day. 

The  theory  of  laissez  faire  which,  in  the  early  part 
of  the  nineteenth  century,  held  full  sway,  emphasized 
the  value  of  individual  liberty.  The  conception  of 
individual  liberty,  however,  did  not  take  into  account 
the  fact  that  mere  permission  to  do  a  thing  is  not  the 
370 


THE   ORGANIZATION  OF  LABOR  371 

same  as  granting  power  to  do  it.  Theoretically,  under 
the  laws  which  were  so  well  thought  of  by  the  early 
individualists,  any  man  had  the  right  to  engage  in  any 
industry  he  pleased,  conduct  that  industry  as  he 
pleased,  pay  his  workmen  what  he  pleased,  and  so  forth. 
At  the  same  time  any  one  also  had  the  right  to  change 
his  employment  when  he  wished,  to  bargain  for  higher 
wages,  to  refuse  to  work  for  less  than  a  certain  sum,  and 
to  go  where  he  pleased  in  search  of  work.  In  practice, 
however,  this  liberty  was  illusory.  The  owner  of 
capital  was  in  the  better  position  almost  invariably. 
What  was  the  use  of  the  workman  exercising  his  right 
to  change  his  employment,  when  the  change  could  not 
result  in  an  improvement  ?  In  case  he  refused  to  work 
for  less  than  a  certain  wage,  he  was  powerless  to  en- 
force the  payment  of  that  wage. 

The  much  praised  freedom  of  competition  of  laborer 
with  laborer  tended  inevitably  toward  the  forcing  of 
the  wages  of  the  laborer  and  the  conditions  of  his 
labor  to  the  lowest  level. 

We  have  not  the  space  in  the  present  discussion  to 
give  any  account  of  the  evils  which  unrestricted  com- 
petition of  laborer  with  laborer  and  manufacturer 
with  manufacturer  led  to.  As  an  illustration,  however, 
it  may  be  mentioned  that  in  the  early  years  of  the 
nineteenth  century  in  England  medical  testimony  was 
called  and  gravely  discussed  to  prove  whether  it  was 
unhealthy  for  a  child  of  eight  or  ten  to  work  for  four- 
teen hours  a  day. 

The  fact  was  that  laborers  could  not  hope  to  im- 
prove their  condition  by  individual  bargaining,  rely- 
ing upon  the  generosity  of  their  employers  to  see  that 


372  AN  INTRODUCTION   TO   ECONOMICS 

they  received  sufficient  to  keep  them  and  their  families 
from  starvation.  There  were  two  alternatives.  Either 
the  laborers  were  to  become  mere  serfs,  cared  for  by 
their  masters  in  the  same  way  that  cattle  and  horses 
are  cared  for,  or  else  they  must  combine  and  add  to 
their  bargaining  strength  by  union. 

The  early  attempts  at  union  were  most  bitterly 
fought.  Every  weapon  that  could  be  suggested  was 
used  against  the  unions.  A  parliament  elected  on  a 
restricted  franchise,  corrupt,  and  biased  against  all 
industrial  agitations,  fearful  of  outbreaks  or  revolu- 
tions, passed  law  after  law  prohibiting  this,  that,  and 
the  other  group  of  workmen  from  combining  to  secure 
increases  in  wages. 

Not  content  with  passing  individual  laws  at  the 
solicitation  of  manufacturers  in  certain  industries, 
these  laws  were  codified  into  a  solid  group  affecting 
all  workmen,  no  matter  what  trade  they  carried  on. 
The  common  law  was  invoked  to  render  workmen 
liable  to  be  sentenced  for  conspiracies  in  restraint  of 
trade. 

Out  of  this  chaos  of  trade  which  tacitly  permitted 
employers  to  combine,  but  persecuted  labor  combina- 
tions, was  born  the  struggle  to  obtain  legal  recogni- 
tion of  the  right  .to  organize. 

The  Right  to  Organize  —  It  is  worth  our  while  to 
consider  the  importance  of  this  right  on  the  part  of 
labor  to  organize  itself.  We  have  already  seen  that 
the  tendency  of  all  our  modern  industrial  development 
is  toward  the  elimination  of  competition.  This  is  so 
in  the  case  of  labor,  as  in  most  other  cases.  The 
individual  laborer  who  comes  to  an  employer  asking 


THE   ORGANIZATION   OF  LABOR  373 

for  a  job  is,  as  a  general  rule,  in  a  poor  situation  to 
bargain  for  his  wages.  He  must  take  what  is  offered. 
It  is  only  when  he  is  backed  by  an  organization  that 
he  can  insist  on  a  minimum  wage  and  definite  standards 
of  treatment. 

The  right  to  organize  implies  the  right  to  do  collec- 
tively what  is  permitted  to  be  done  by  the  individual. 
Any  individual  may,  if  he  wishes,  refuse  to  work  for 
any  other  individual.  If  John  Jones  does  not  like  to 
work  for  Tom  Smith,  he  does  not  need  to,  and  it  does 
not  make  any  difference  if  Tom  Smith  happens  to  be 
Thomas  Smith  and  Company,  Inc.  This  individual 
right  was  acknowledged  in  the  laissez  faire  period. 
But  what  was  right  in  the  individual  became  wrong 
in  the  association.  The  association  is  powerless, 
however,  unless  it  is  granted  the  right  to  make  use  of 
its  collective  importance.  It  makes  very  little  dif- 
ference to  Thomas  Smith  and  Company,  if  John  Jones 
resigns.  But  it  makes  a  very  great  difference  if 
John  Jones  is  accompanied  by  all  of  his  fellow  work- 
men. In  other  words,  when  it  comes  to  a  trial  of 
strength,  the  association  has  a  power  which  is  not 
possessed  by  the  individual.  The  right  to  strike, 
therefore,  is  essential  to  the  organization  of  workmen, 
unless  there  are  other  and  more  satisfactory  methods 
of  gaining  improvements  in  wages  and  conditions  of 
labor. 

This  involves,  of  course,  the  right  of  the  employers 
to  organize  as  well.  But  no  one  has  ever  questioned 
this  right ;  it  has  been  taken  for  granted.  The  point 
we  wish  to  emphasize  is  this;  if  it  is  assumed  that 
conditions  of  industry  are  to  be  governed  by  the 


374  AN  INTRODUCTION   TO   ECONOMICS 

bargain  made  between  the  employers  and  the  work- 
men, it  is  only  fair  that  the  parties  should  be  in  nearly 
equal  positions  in  settling  the  bargain.  To  give  either 
party  an  invariably  preponderant  power  is  bound  to 
result  in  oppression  of  the  other. 

We  are  now  in  a  position  to  define  the  meaning  of 
trade  union.  We  shall  find,  however,  on  further  ex- 
amination that  the  varieties  of  trade  unions  make  it 
necessary  to  give  subdivisions  which  must  be  further 
defined.  As  a  general  statement,  we  may  say  a  trade 
union  is  an  organization  of  workmen  which  has  for 
its  primary  object  the  obtaining  of  increases  in  wages 
and  the  improvement  of  conditions  of  labor. 

The  Methods  of  Organization  —  Experiments  with- 
out number  have  been  made  in  the  organization  of 
trade  unions.  Hardly  any  scheme  which  has  been 
suggested  for  the  conduct  and  improvement  of  demo- 
cratic government  has  not  been  tried.  It  is  difficult 
to  say  that  any  particular  trade  union  is  typical. 
There  are,  however,  two  distinct  and  broad  types  which 
are  worthy  of  consideration  in  the  present  brief  dis- 
cussion. 

There  is,  first,  the  craft  union.  In  this  case  the  work- 
men are  associated  with  one  another  by  similarity  of 
work.  The  carpenters  form  a  group  of  their  own, 
each  knowing  exactly  what  difficulties  occur  in  the 
carpenter's  work,  the  conditions  which  should  be  im- 
proved, and  so  forth.  The  bricklayers  form  another 
union,  which  is  concerned  purely  with  the  work  of 
bricklayers.  It  is  in  this  sort  of  union,  which  is  con- 
fined to  the  members  of  a  particular  craft,  that  the 
similarity  is  seen  between  the  trade  union  and  the 


THE   ORGANIZATION  OF  LABOR  375 

craft  gild.  The  difference  is  obvious,  however.  The 
trade  union  is  definitely  an  organization  of  employees, 
as  distinguished  from  employers;  the  craft  gild  in- 
cluded both.  As  the  association  grows  in  size,  the 
trade  union  tends  to  affiliate  with  similar  organiza- 
tions in  different  places.  But  it  is  important  to  re- 
member that  it  affiliates  with  organizations  in  the 
same  trade.  The  machinists  union  of  one  city  affili- 
ates with  the  machinists  union  in  another.  There  is 
no  suggestion  of  an  association  of  painters  and  black- 
smiths. The  trade  lines  are  kept  distinct. 

National  Association  —  As  it  comes  to  be  realized  that 
national  associations  are  of  great  value,  in  other  words, 
as  the  organization  becomes  nation-wide  in  its  scope, 
the  dependence  of  one  trade  upon  another  is  more 
strongly  realized.  At  the  time  of  writing,  for  instance, 
a  strike  of  a  certain  number  of  boiler  makers  and 
machinists,  the  actual  number  of  strikers  numbering 
perhaps  two  or  three  thousand,  has  caused  the  idleness 
of  over  thirty  thousand  workmen.  In  order  to  pro- 
duce common  action,  some  central  organization  asso- 
ciated with  all  grades  is  required,  so  that  all  industrial 
workers  shall  not  be  at  the  mercy  of  a  small  group, 
and  at  the  same  time  the  small  group  in  what  is  deemed 
a  right  cause  shall  have  the  support  of  the  whole. 
This  association  is  formed  on  the  principle  of  a  federa- 
tion. Each  trade  union  is  autonomous  as  far  as  its 
peculiar  affairs  are  concerned.  But  each  is  compelled 
in  matters  affecting  all  to  submit  to  the  orders  of  the 
central  council. 

The  national  organization  becomes  a  federation  of  self- 
governing  unions,  each  with  its  own  national  council. 


376  AN  INTRODUCTION   TO   ECONOMICS 

The  tendency  is  all  the  time  toward  centralization. 
Perhaps  the  best  analogy  is  that  of  the  government  of 
the  United  States  itself.  Here  we  have  a  series  of 
forty-eight  states  each  with  its  own  central  organiza- 
tion, in  the  form  of  legislative  assemblies  with  their 
officials  and  executive  staffs.  All  purely  local  matters, 
that  is,  all  matters  that  have  to  do  with  those  within 
the  state  alone,  are  settled  according  to  the  will  of  the 
central  organization.  But  all  matters  that  have  to  do 
with  inter-state  affairs  are  settled  by  an  organization 
controlling  the  action  of  the  states  —  the  Federal 
Government. 

The  difference  between  the  government  of  the 
states  and  of  the  country  on  the  one  hand,  and  the 
government  of  the  trade  unions  on  the  other,  is  largely 
due  to  the  restriction  of  the  number  of  individuals 
within  the  country  and  within  the  trade  unions. 
The  trade  unions  that  have  this  federal  organization 
include  among  their  members  only  the  workers  in  the 
organized  crafts. 

The  American  Federation  of  Labor,  which  is  the 
great  central  organization  of  labor  in  this  country,  is, 
however,  not  entirely  representative  of  labor  through- 
out the  country.  It  represents  rather  a  class  of  labor 
—  the  skilled  trades.  It  has  very  little  to  do  with  the 
great  mass  of  unskilled  laborers.  There  is,  it  is  true, 
a  tendency  at  present  to  widen  its  scope  to  include 
laborers  without  a  trade,  but  even  in  so  doing,  it 
desires  to  allot  these  laborers  to  the  trades  toward 
which  they  incline. 

Essentially,  the  American  Federation  of  Labor  be- 
lieves in  trade  unions  rather  than  in  a  trades  union. 


THE    ORGANIZATION   OF   LABOR  377 

The  distinction  is  of  great  importance,  for  it  emphasizes 
the  tendency  which  is  becoming  stronger  every  day, 
to  change  toward  an  organization  of  labor  which  ignores 
the  difference  in  trades.  Industrial  unionism,  as  it  is 
called,  believes  in  the  fundamental  solidarity  of  labor. 
All  workmen,  according  to  its  creed,  have  the  same 
difficulties  to  contend  with,  and  only  by  combining  as 
a  whole  can  they  achieve  the  solution  of  their  diffi- 
culties. In  the  industrial  union,  or  as  it  was  known  in 
English  labor  history,  the  trades  union,  the  unit  is  a 
geographical  one,  rather  than  a  craft  unit.  The  large 
geographical  units  are  split  into  smaller  geographical 
units  until  we  arrive  at  last  at  the  fundamental  unit, 
the  shop. 

There  are  distinct  advantages  claimed  for  this  basis 
of  organization.  In  the  first  place,  the  men  who  are 
at  work  in  a  single  shop  or  plant  know  best  the  condi- 
tions which  affect  themselves.  They  know  that  the 
strike  of  one  particular  trade  in  the  shop  may  bring 
about  the  idleness  of  all  the  workers  in  that  shop. 
Hence  it  appears  that  an  organization  which  includes 
all  the  workers  will  have  a  better  chance  to  arrive 
at  a  proper  decision  worthy  of  the  action  of  all  com- 
bined, than  when  one  group,  for  a  reason  affecting  only 
that  group,  drags  all  into  the  struggle. 

Again,  when  all  the  workers  are  united  into  a  single 
union,  there  is  better  chance  for  a  truly  united  action, 
and  therefore  a  successful  action,  than  when  the 
trades  are  separately  organized,  with  the  unskilled 
workers  unorganized.  There  will  be  no  possibility  of 
jealousy  in  regard  to  the  trade  divisions.  With  craft 
unions  there  is  always  a  tendency  for  the  division  be- 


378  AN   INTRODUCTION   TO   ECONOMICS 

tween  crafts  to  become  vague  and  indistinct.  In  the 
engineering  trades,  for  example,  there  are  pattern- 
makers, whose  work  bears  a  strong  similarity  to  that  of 
carpenters.  Yet  the  unions  are  separate.  In  some 
cases,  these  differences  which  seem  so  slight  lead  to 
awkward  complications,  each  union  claiming  that  the 
other  is  encroaching  upon  work  which  rightly  belongs 
to  the  claimant. 

The  industrial  union,  it  is  also  claimed,  leads  to  a 
feeling  of  community  of  interest  which  is  of  great  value 
in  the  struggle  between  labor  and  capital. 

The  chief  exponent  of  the  industrial  union  in 
America  is  the  association  known  as  the  Industrial 
Workers  of  the  World,  or,  more  briefly,  the  I.  W.  W. 
While  the  I.  W.  W.  represents  the  "  industrial  "  attitude, 
as  distinguished  from  the  "  craft  "  idea,  however,  it 
has  political  and  social  aims  which  are  extraneous  to 
the  present  discussion. 

The  Shop  Steward  Movement  —  The  final  matter 
which  must  be  dealt  with  under  the  consideration  of 
the  organization  of  labor  is  the  rise  of  a  new  and  very 
important  union  officer,  the  shop  steward.  The  shop 
steward  movement  represents  the  tendency  to  break 
away  from  the  craft  union  and  to  develop  the  industrial 
union.  Even  in  the  craft  unions  it  has  often  been  felt 
that  the  central  control  exercised  by  the  national 
organization  of  the  craft,  has  been  too  far  separated 
from  the  conditions  in  any  particular  plant.  Some  one 
closely  connected  with  the  actual  daily  work  in  the 
plant,  familiar  with  everything  that  is  going  on,  it 
was  thought,  should  represent  the  workers  within  that 
plant.  An  individual  has  been  appointed,  not  rep- 


THE    ORGANIZATION   OF   LABOR  379 

resenting  any  particular  union  in  the  plant,  but  rather 
representing  all  unions.  His  duty  is  to  watch  for 
attempts  at  increasing  the  hardship  of  the  laborers, 
whatever  their  occupation,  and  to  represent  the  united 
employees  in  disputes  within  the  plant. 

With  the  advent  of  the  shop  steward,  it  becomes 
evident  that  there  is  a  tendency  to  break  away  from 
the  central  control.  This  tendency  is  seen  with  in- 
creasing frequency  in  the  labor  disputes  that  occur  at 
the  time  of  writing.  Local  unions  refuse  to  abide  by 
the  decision  of  their  national  organization,  claiming, 
often,  that  the  national  officials  are  out  of  touch  with 
the  actual  conditions  in  the  locality.  As  to  the  outlook 
for  future  development  we  shall  say  nothing  here,  but 
consider  this  matter  under  another  head  later  on. 

Aims  of  Labor  Organizations  —  Labor  organization 
is  only  a  means  toward  an  end,  not  an  end  in  itself. 
The  question  now  arises,  what  are  the  aims  which  the 
organized  laborers  seek  to  attain?  They  may  be 
summed  up  in  a  very  few  words  —  the  betterment 
of  the  laboring  classes.  It  will  be  well,  however,  to 
divide  these  aims  into  four  groups. 

1.  Collective  Bargaining  —  The  original  cause  which 
drove  laborers  to  organize  was  the  fact  that  the  in- 
dividual was  powerless  to  bargain  for  good  conditions 
of  labor.  As  an  individual  he  was  unimportant,  so  long 
as  there  was  an  abundance  of  labor.  In  order  to  obtain 
good  conditions  of  labor,  the  effect  of  an  abundance  of 
labor  in  the  market  must  be  removed.  The  only  way 
to  do  this  was  to  increase  the  size  of  the  bargaining  unit. 
It  meant  nothing  to  an  employer  if  one  workman  asked 
for  an  increase  in  wages  or  a  reduction  in  the  hours  of 


380  AN   INTRODUCTION   TO   ECONOMICS 

work;  he  could  always  get  another  to  do  the  work 
at  the  old  rate.  But  it  was  a  very  different  matter 
when  a  large  body  demanded  a  change.  It  was  not 
so  easy  to  replace,  at  a  moment's  notice,  half  of  his 
workmen.  Hence  if  the  bargaining  for  improved  con- 
ditions was  done  by  a  large  group,  instead  of  by  the 
individual  members  of  that  group,  the  chances  of  success 
on  the  part  of  the  laborers  were  materially  improved. 
One  of  the  fundamental  aims  of  all  organized  labor, 
therefore,  has  always  been  that  bargains  for  the  change 
of  conditions  of  labor  should  be  made  collectively. 
An  increase  in  wages  or  a  reduction  in  hours  should 
affect  all  of  the  workers  and  not  one  individual.  It  is 
true  that  this  meant,  possibly,  a  reduction  in  wages 
for  a  particularly  strong  or  particularly  skilled  laborer, 
and  an  increase  for  a  comparatively  inefficient  work- 
man, but  on  the  whole  it  meant  that  a  decent  wage 
would  be  secured  by  all.  The  trade  unions  have  al- 
ways claimed  that  the  rate  set  for  payment  of  wages 
by  individual  bargaining  has  tended  to  be  decided  by 
what  the  poorest  would  take,  rather  than  what  each 
earned,  so  that  payment  on  the  basis  of  average  work 
meant  an  improvement  to  all. 

2.  Standard  Wage  —  We  have  already  seen  in  a 
previous  chapter  that  the  greatest  cause  of  poverty  is 
low  wages.  After  the  principle  of  collective  bargaining 
has  been  secured  by  the  labor  unions,  the  next  step, 
and  by  far  the  most  important,  is  the  securing  of  better 
wages.  No  matter  on  what  philosophy  the  demand 
be  based,  and  many  reasons  are  given  for  every  effort 
at  gaining  greater  remuneration,  the  fundamental 
fact  is  that  each  workman  believes  that  his  lot  would  be 


THE    ORGANIZATION    OF    LABOR  381 

improved  by  an  increase  in  his  wages.  Wages  represent 
to  him  the  satisfaction  of  his  desires.  When  his  desires 
outstrip  the  possibility  of  satisfying  them,  he  demands 
higher  wages.  This  appears  to  be  a  state  of  affairs 
which  can  never  be  improved.  As  the  wages  advance 
so  do  the  desires.  This  is  not  necessarily  an  evil.  If 
we  remember  the  problem  with  which  we  set  out,  we 
must  recognize  that  the  advance  of  civilization  depends 
largely  upon  the  increase  in  the  desires  of  mankind, 
coupled  with  the  means  of  satisfying  those  desires. 

The  labor  unions  believe  that  a  greater  share  of  the 
results  of  industry  should  belong  to  the  workers  — 
using  the  word  in  its  limited  meaning.  Hence  their 
demand  that  wages  be  increased  seems  perfectly 
reasonable.  Of  course  labor  has  recognized  the  differ- 
ence between  money  wages  and  real  wages.  In  all 
modern  efforts  at  increase  of  wages,  a  strong  point  is 
made  of  the  increase  in  the  cost  of  living.  Constant 
studies  are  made  of  the  variation  in  the  purchasing 
power  of  money.  Before  the  war  it  was  estimated  by 
the  United  States  Bureau  of  Labor  that  $800  was  neces- 
sary to  support  a  working-class  family  for  a  year.  The 
latest  estimate  is  somewhat  over  $1700.  If,  therefore, 
wages  have  doubled,  the  workman  has  not  gained,  but 
lost  slightly.  Yet  the  unions  have  had  to  make  bitter 
fights  to  keep  wages  rising  to  meet  the  cost  of  living. 

The  basis  of  the  union  philosophy  is  that  the  workman 
should  not  be  considered  as  a  commodity,  but  as  a  man 
and  as  a  citizen.  Hence  his  welfare  is  as  important 
as  that  of  any  member  of  the  community. 

3.  Conditions  of  Labor  —  Arising  out  of  that  philos- 
ophy, the  unions  have  demanded  that  the  conditions 


382  AN   INTRODUCTION   TO   ECONOMICS 

under  which  a  workman  has  to  perform  his  daily 
task  should  be  congenial.  Good  sanitary  workshops, 
safety  against  dangerous  machinery,  and  so  forth,  are 
all  of  importance.  Hence  the  unions  have  striven,  by 
collective  bargaining,  and  by  a  certain  amount  of 
pressure  upon  legislatures,  to  secure  improvement  in 
these  conditions.  The  justice  of  this  demand  has  long 
been  recognized  and  state  after  state  in  this  country 
has  passed  factory  laws  which  have  for  their  aim  the 
protection  of  the  workmen  against  conditions  of  labor 
which  were  detrimental  to  their  welfare,  and  thus 
demoralizing  to  the  community. 

4.  Hours  of  Labor  —  It  is  curious  to  note,  in  the 
history  of  labor  organization,  the  gradual  steps  which 
have  been  taken  toward  securing  shorter  hours  of  labor. 
At  first  hours  of  labor  seemed  somewhat  unimportant. 
No  one  thought,  or  seemed  to  think,  that  part  of  the  day 
should  be  used  for  the  purpose  of  leisure  or  amusement. 
Defoe  paints  what  he  considered  a  beautiful  picture 
of  the  labor  of  his  times  —  the  busy  housewife  working 
at  her  spinning  wheel,  the  husband  weaving  or  tending 
to  the  work  of  the  small  farm,  the  children,  even  the 
very  youngest,  engaged  in  carding  wool  or  assisting 
with  the  work  in  many  ways.  Possibly  it  was  a  relic 
of  the  puritanical  objection  to  all  amusement  and 
idleness.  At  any  rate  the  common  feeling  was  that 
those  who  gave  every  minute  of  their  waking  life  to 
work  were  doing  what  was  right  and  proper. 

Hours  of  labor  prolonged  unduly,  however,  were 
bound  sooner  or  later  to  arouse  objections  on  the  part 
of  the  workers.  Sixteen  hours  a  day  used  to  be 
considered  as  almost  reasonable.  Then  there  arose 


THE    ORGANIZATION    OF    LABOR  383 

the  cry  for  a  fourteen-  and  a  twelve-hour  day.  A  long 
and  bitter  struggle  was  waged  in  England  to  secure  the 
ten-hour  day.  At  present  it  is  generally  assumed 
that  eight  hours  represents  a  fair  day's  work,  al- 
though far  too  many  work  for  much  longer  periods. 
There  is  an  agitation  going  on,  headed,  it  may  be  noted, 
not  by  a  workman  but  by  an  employer  of  labor,  for  a 
reduction  to  six  hours  a  day. 

It  has  been  urged  against  the  working  class  that  this 
constant  demand  for  a  reduction  of  the  hours  of  labor 
is  an  indication  of  congenital  laziness.  We  are  all,. 
however,  more  or  less  lazy.  That  only  means  that 
we  do  not  want  to  be  doing  the  same  action  for  too 
long  a  space  of  time.  Work  in  itself,  as  has  already 
been  pointed  out,  is  not  the  aim  of  life.  It  is  a  means 
to  an  end  and  the  end  is  the  attainment  of  our  highest 
development.  \Vork  which  does  not  lead  to  such 
development  is  not  to  be  encouraged.  Of  course  a 
certain  amount  of  drudgery  is  to  be  expected,  but  that 
amount  should  be  curtailed  to  the  greatest  possible 
extent.  Labor-saving  machinery  has  been  invented 
for  the  purpose  of  allowing  greater  production  with  less 
effort.  To  attempt  to  increase  production  by  the  use 
of  such  inventions  without  reducing  the  actual  amount 
of  work  performed  is  to  remove  the  blessing  from  the 
discoveries.  The  workman  feels  more  and  more,  as 
time  passes,  that  there  is  more  to  life  than  merely 
working.  He  demands  that  he  be  able  to  secure  a 
livelihood  without  working  all  the  time,  so  that  he 
can  use  part  of  the  day  to  enjoy  as  he  pleases. 

The  demand  made  by  the  labor  unions  for  the 
abolition  of  overtime  is  due  to  a  twofold  reason. 


384  AN   INTRODUCTION   TO   ECONOMICS 

Partly  it  is  urged  as  a  cure,  or  at  least  a  palliative  for 
unemployment,  but  also  for  the  reason  that  leisure  is  a 
rightful  demand  in  itself.  Now  in  both  of  these  claims 
there  cannot  be  the  slightest  doubt  that  the  unions  are 
right.  A  certain  amount  of  work  is  good  for  a  man, 
but  too  much  is  as  bad  as  none  at  all.  It  is  true  that 
some  find  their  recreation  in  work  itself.  These, 
however,  are  the  minority.  There  is  no  value  either,  in 
the  argument  that  the  laborers  would  abuse  their 
leisure. 

When  the  demand  is  made  for  the  limitation  of  child 
labor  it  is  unanswerable.  The  amount  of  child  labor 
which  exists  at  the  present  time  is  a  disgrace  to  civili- 
zation. It  can  at  least  be  argued  that  the  adult  may 
refuse  to  work  if  he  pleases  (the  argument  is  not  sound), 
but  the  child  cannot.  To  force  him  to  work  at  an  age 
when  he  should  be  playing  is  one  of  the  gravest  blots 
on  our  modern  society. 

Trade  Union  Methods  —  The  trade  union  is,  espe- 
cially in  this  country,  a  fighting  organization.  It  is 
based  on  the  belief  that  the  battle  is  to  the  strong,  and 
it  endeavors  to  increase  its  strength  in  order  to  gain 
the  victory.  The  great  weapon  which  organized  labor 
possesses  is  the  right  to  strike.  A  strike  is  a  con- 
certed refusal  to  work  by  a  group  of  employees,  with 
the  purpose  of  securing  redress  of  grievances.  It  is 
tacitly  understood  that  the  hiring  of  labor  is  a  bargain 
between  the  employer  and  the  employee.  The  em- 
ployee therefore  reserves  to  himself  the  right  to  refuse 
to  perform  his  side  of  the  bargain  unless  the  conditions 
of  the  contract  are  to  his  liking.  As  we  have  said, 
when  the  bargain  was  between  individual  laborer  and 


THE   ORGANIZATION   OF   LABOR  385 

individual  employer  all  the  strength  lay  on  one  side. 
In  order  to  equate  the  strength  of  the  parties,  the  refusal 
to  work  must  be  made  by  all,  or  at  least  a  large  pro- 
portion of  the  workers  at  one  time. 

Such  trials  of  strength  are  not  things  to  be  desired. 
Strikes  are  a  form  of  warfare,  and  warfare  is  always 
wasteful.  The  strike,  however,  is  the  last  resort,  the 
final  weapon  in  the  hands  of  the  laborer.  It  is  indeed 
true  that  often  he  has  been  inclined  to  resort  to  his 
final  weapon  before  using  milder  methods.  That, 
however,  is  incidental  to  a  certain  stage  of  development. 
Our  forefathers  used  to  settle  their  private  disputes  by 
means  of  duels.  Nowadays  we  resort  to  legal  settle- 
ments. In  the  early  days  of  the  mining  industries 
and  in  the  cattle  countries,  the  bowie  knife  and  the 
revolver  settled  all  disputes.  We  have  outgrown  that 
stage  now.  The  same  is  true  of  the  war  between 
capitalist  and  laborer.  We  have  not,  certainly,  got 
rid  entirely  of  what  we  may  call  the  revolver  stage  of 
settlement,  but  we  are  getting  rid  of  it.  It  is  better 
ordered  and  controlled  than  it  used  to  be. 

In  every  method  used  by  the  trade  union,  there  is  a 
counterpart  in  the  methods  adopted  by  the  employers. 
The  strike  of  the  workmen  is  replied  to  by  the  lockout 
of  the  employers.  A  lockout  is  the  simultaneous  dis- 
charge of  all  workmen  or  a  large  proportion  of  them, 
from  a  certain  industry  or  a  certain  plant,  in  order  to 
force  them  to  agree  to  terms  laid  down  by  the  employers. 
Here  again,  we  have  the  other  side  of  the  revolver 
argument. 

Now  just  as  it  was  true  in  the  early  days  in  the 
cattle  country  that  the  revolver  was  necessary  because 


386  AN   INTRODUCTION   TO   ECONOMICS 

the  law  did  not  exist,  so  it  is  true  that  the  strike  and 
lockout,  as  a  trial  of  strength  between  the  parties,  are 
necessary  now  because  there  is  no  law.  By  law,  of 
course,  we  mean  definite  order  for  the  securing  of 
redress  of  grievances  on  each  side. 

Arbitration  and  Conciliation  —  This  leads  us  to  the 
consideration  of  some  of  the  suggestions  for  settling 
disputes.  Of  these  principally  there  are  two  varieties. 
The  first  is  arbitration.  The  usual  method  is  for  each 
party  to  choose  a  representative  on  the  board  of  arbi- 
tration and  for  these  two,  or  some  outside  body  like 
the  Department  of  Labor,  to  nominate  a  third.  Arbi- 
tration, however,  is  limited  in  its  scope.  If  there  has 
been  an  existing  agreement  between  the  disputants, 
who  cannot  agree  upon  the  interpretation  of  this  agree- 
ment, arbitration  may  be  of  some  value.  If,  on  the 
other  hand,  the  question  arises  of  making  a  new 
agreement,  arbitration  is  unsatisfactory. 

If  the  two  parties  to  the  dispute  are  so  at  loggerheads 
with  each  other  that  the  settlement  seems  impossible 
without  a  trial  of  strength  through  a  strike  or  lockout , 
then  it  may  be  possible  for  a  disinterested  outsider  to 
endeavor  to  bring  the  two  together  and  eliminate  the 
principal  points  of  disagreement  and  bring  about  a 
settlement  of  the  dispute.  This  method,  the  method  of 
conciliation,  is  more  useful  in  coming  to  a  new  agree- 
ment than  in  interpreting  an  old  one. 

Governments  have,  from  time  to  time,  insisted  that 
one  or  other  of  these  last  two  methods  should  be 
attempted  before  coming  to  a  strike  or  lockout.  One 
very  strong  objection  has  been  urged,  on  the  part  of 
the  workmen,  against  arbitration.  They  argue  that  in 


THE    ORGANIZATION   OF   LABOR  387 

a  great  proportion  of  the  cases,  the  board  is  composed,  as 
far  as  its  majority  is  concerned,  of  people  who  have 
an  instinctive  although  often  unconscious  bias  against 
the  labor  side.  The  lawyer  or  judge  who  is  often  chosen 
as  chairman  of  the  board  is  almost  always  drawn  from 
the  same  class  as  the  employer. 

The  Boycott  and  the  Union  Label  —  Another  method 
of  forcing  employers  to  grant  demands  of  laborers  is 
the  use  of  the  boycott.  This  means  that  the  unions, 
and  as  many  others  as  the  unions  can  persuade,  refuse 
to  purchase,  use,  or  handle  goods  made  by  the  re- 
calcitrant employer.  This  is  answered  by  the  black- 
list on  the  part  of  the  employers.  Objectionable 
workmen,  i.e.,  those  who  have  been  prominent  in  union 
agitations,  are  refused  work  wherever  they  apply. 

To  some  extent  the  unions  endeavor  to  enlist  the 
general  consuming  public  on  their  side,  by  urging  them 
to  purchase  only  such  goods  as  are  made  under  good 
conditions.  The  public  is  able  to  judge  which  are  so 
produced  by  a  label  which  is  attached  when  the  goods 
are  made  by  union  labor.  Employers  have  themselves 
made  use  of  this  sympathetic  feeling  on  the  part  of  the 
public  by  advertising  the  fact  that  their  manufactures 
bear  the  union  label. 

The  Success  of  Trade  Unionism  —  It  is  very  diffi- 
cult to  estimate  the  success  which  has  been  attained 
by  the  trade  unions.  The  estimate  varies  according 
to  the  standing  of  the  estimator.  There  cannot  be 
any  doubt,  however,  that  the  trade  unions  have  been  of 
great  assistance  in  raising  the  standard  of  life.  That 
their  methods  have  not  been  always  those  of  the  most 
enlightened  may  be  granted.  On  the  other  hand  it 


388  AN    INTRODUCTION   TO    ECONOMICS 

cannot  be  said  that  a  very  satisfactory  example  has 
been  given  by  their  employers,  who  have  usually,  at 
any  rate,  the  advantage  of  a  better  education. 

Trade  unionism  has  served  to  bring  forcibly  to  the 
eyes  of  the  public  the  fact  that  workers  have  rights  as 
well  as  duties.  It  is  unfortunate  that  society  has  not 
been  able  to  learn  this  lesson  without  bitter  suffering 
on  the  part  of  the  unionists  themselves,  and  very  great 
inconvenience,  if  not  actual  suffering,  on  the  part  of 
the  community. 

In  the  foregoing  discussion  care  has  been  taken  to  give 
a  fair  account  of  the  aims  and  methods  of  organized 
labor.  Many  individual  cases  of  unjustifiable  methods 
have  been  overlooked.  It  is  not  suggested  that  in 
every  case  of  a  dispute  the  workmen  have  invariably 
been  in  the  right.  This  is,  of  course,  untrue.  Nor  is  it 
suggested  that  in  defending  their  own  position,  em- 
ployers have  always  been  oppressive.  It  would  be 
quite  impossible  in  the  space  which  we  can  give  to 
this  discussion,  to  deal  adequately  with  all  sides  of  the 
question.  There  have  been  grievous  mistakes  on  both 
sides  but,  taking  a  broad  view  of  the  development  of 
the  principle  and  methods  of  collective  bargaining,  and 
of  the  trade  unions  themselves,  it  is  demonstrably  true 
that  they  have  been  of  immense  service  not  only  to  their 
own  members,  but  also  to  the  general  community  in 
raising  standards  of  living  and  thus  helping  to  provide 
for  a  higher  development  of  humanity. 


CHAPTER  XXVIII 

DISTRIBUTION   AND  THE  LABOR  PROBLEM 

From  the  remarks  made  in  the  previous  chapter  it 
should  be  clear  that  the  great  problem  which  has  con- 
fronted the  laboring  classes,  using  the  term  in  the 
commonly  accepted  meaning,  has  been  the  readjust- 
ment of  the  distribution  of  wealth.  The  laborers  have 
felt  that  they  were  not  getting  a  fair  share  of  the 
wealth  produced.  They  have  not  been  blind  to  the  ob- 
vious distinction  between  the  great  fortunes  on  the  one 
hand  and  the  practical  poverty  of  great  masses  of 
the  people  on  the  other.  It  is  not  true  to  suggest, 
however,  that  the  workmen  have  always  had  their  eyes 
focused  on  these  inequalities.  If  they  had,  one  can 
hardly  doubt  that  revolutions  would  have  occurred 
before  this.  In  order 'to  understand  the  history  of  the 
labor  movement  a  little  insight  into  ordinary  psychology 
is  valuable.  Few  of  us  are  capable  of  taking  a  broad 
view  of  life  or  of  weighing  arguments  pro  and  con  on 
important  subjects.  We  all,  or  nearly  all,  consider 
those  things  which  immediately  and  obviously  affect 
us  as  of  most  importance.  Consequently  when  there  is 
discontent,  the  causes  which  are  alleged  to  have  pro- 
duced this  discontent  are  almost  as  many  as  the  number 
of  the  discontented. 

Petty  difficulties  arising  in  an  individual  plant 
or  workshop  may  be  the  apparent  cause  of  a  totally 
389 


390  AN    INTRODUCTION    TO    ECONOMICS 

disproportionate  dispute.  We  are  all  prone  to  gen- 
eralize from  our  personal  experience  and  to  reject  as 
irrelevant  causes  of  evils  which  are  suggested  by  those 
who  have  only  a  "  theoretical  "  acquaintance  with  the 
subject.  The  writer  once  suggested  to  a  group  of 
workingmen,  mostly  trade  unionists,  that  a  thorough 
acquaintance  with  the  history  of  the  trade  union 
movement  would  help  to  remove  from  the  discussion 
of  possible  remedies  for  discontent,  causes  which, 
though  they  might  exist,  were  of  slight  importance. 
One  workman  replied  that  he  did  not  intend  to 
read  the  history  suggested  as  it  "might  change  his 
opinions." 

Now  this  is  obviously  an  absurd  standpoint,  but  it 
is  not  an  unnatural  one.  Those  causes  of  which  we  have 
immediate  knowledge  invariably  have  more  influence 
with  us  than  those  which  are  the  result  of  investigation 
extended  into  unfamiliar  ground.  Hence  we  find  all 
sorts  of  wild  ideas  as  to  the  causes  of  inequalities  in  the 
distribution  of  wealth.  It  is  quite  impossible  in  the 
present  work  to  deal  with  all  of  the  causes  of  evils  in 
distribution  which  are  believed  by  one  or  other  group 
to  be  important.  Furthermore  it  is  impossible  to  do 
more  than  cite  a  few  of  the  remedies  proposed. 

Essentially  we  may  distinguish  four  criticisms  with 
the  corresponding  proposals  for  removing  the  bases 
of  these  criticisms.  The  first  is  to  the  effect  that  the 
workers  do  not  receive  a  share  in  the  profits  of  industry ; 
the  second,  that  industry  is  not  subject  to  control  by 
the  workmen ;  next,  the  tax  system  is  claimed  to  be 
unjust ;  and  finally,  the  whole  foundation  of  our 
economic  life,  as  it  is  at  present  organized,  is  declared 


DISTRIBUTION   AND   THE    LABOR   PROBLEM     391 

to  be  wrong.  Of  these  criticisms  we  shall  leave  for 
future  consideration  the  last,  and  the  most  important, 
and  deal  now  with  the  first  three. 

Profit  Sharing  —  The  feeling  that  the  workers,  that 
is,  the  employees  in  a  business  should  receive  a  share 
in  the  profits  of  that  business  or  industry  is  one  which 
has  been  advocated  rather  by  those  in  control  of  the 
industry  than  by  the  workers  themselves.  Indeed  it 
may  be  said  that  the  schemes  of  profit  sharing  which 
have  been  proposed  from  time  to  time  have  been 
regarded  very  unfavorably  by  organized  labor.  This 
is  due  to  the  fact  that,  from  the  labor  point  of  view, 
the  reason  for  profit  sharing  is  not  the  same  as  that 
which  gives  rise  to  its  institution  by  the  employer. 
There  are,  speaking  broadly,  three  different  systems  of 
profit  sharing.  In  the  first  place  a  definition  of  profits 
has  to  be  arrived  at.  As  a  rule,  a  certain  amount  of  the 
earnings  is  earmarked  for  the  payment  of  interest  upon 
capital  and  salaries  of  management.  Commonly,  cap- 
ital is  expected  to  receive  a  rate  of  interest  somewhat 
larger  than  the  average  commercial  rate,  before  profits 
are  computed.  Salaries  of  management  are  considered 
(and  rightly  so  when  they  are  not  obviously  excessive) 
as  part  of  the  cost  of  production.  The  surplus  after 
paying  for  cost  of  production,  including  cost  of  manage- 
ment, labor,  materials,  and  the  stated  rate  of  interest 
on  capital,  is  divided  in  varying  ratios  between  labor, 
management,  and  capital. 

The  first  method  of  making  the  payments  to  labor  is 
to  give  the  share  as  a  cash  bonus  at  the  end  of  the  year. 
This  has  frequently  been  the  first  method  adopted  by 
a  firm  in  starting  the  system.  It  is  claimed,  by  the 


392  AN    INTRODUCTION    TO    ECONOMICS 

employers,  that  this  system  produces  steady  and  ener- 
getic laborers.  From  the  employer's  point  of  view, 
therefore,  the  aim  of  the  institution  of  profit  sharing 
is  to  increase  the  production  of  the  laborers  and  to 
lessen  the  "  turn-over "  of  labor.  From  the  labor 
point  of  view,  it  is  suggested  that  the  profits  which 
the  laborer  receives  at  the  end  of  the  year  are  really 
only  wages  for  the  increased  production  and  therefore 
are  due  entirely  to  the  laborers.  It  is  assumed  that 
capital  is  not  increased  and  that  the  management  is 
not  materially  more  difficult,  so  that  the  increased  pro- 
duction is  due  definitely  to  the  increased  energy  of  the 
workmen.  But  capital,  which  has  done  nothing  more 
than  usual,  receives  a  share  out  of  this  increased  profit 
and  so  also  does  the  management.  Hence  the  laborer 
is  induced  to  work  harder  for  the  sake  of  getting  at 
best  a  little  more  than  a  third  of  the  results  of  his 
increased  production.  This  is  the  basis  of  the  labor 
criticism  of  this  form  of  profit  sharing. 

The  next  form  is  that  in  which  the  dividend  is  not 
paid  in  a  lump  sum  at  the  end  of  the  year,  but  is 
deferred  to  form  a  sort  of  pension  fund  or  life  insurance. 
The  varieties  of  this  form  are  very  great  and  so  a 
general  statement  is  liable  to  err  in  regard  to  indi- 
vidual cases.  It  is  often  stipulated,  however,  that  the 
deferred  payment  ceases  to  belong  to  the  worker 
should  he  leave  the  employ  of  the  company.  This 
system  is  also  believed  by  those  who  have  tried  it  to 
lead  to  steady  work  and  increased  production.  Against 
it,  the  laborer  has  urged  that  its  effect  is  to  prevent 
the  possibility  of  successful  organization  of  laborers. 
The  unions  have  regarded  such  systems  as  being  subtle 


DISTRIBUTION   AND   THE    LABOR  PROBLEM     393 

forms  of  attacks  on  organized  labor  —  "  union-breaking 
schemes." 

The  same  claims  are  made,  on  both  sides,  for  the  third 
form.  In  this  form  the  dividend  of  profits  is  not  made 
in  cash,  or  is  made  only  partly  in  cash,  the  bulk  being 
paid  in  the  form  of  stock  in  the  company,  so  that  the 
workmen  become  shareholders.  In  some  cases  it  has 
been  stipulated  that  such  labor-owned  shares  shall  not 
possess  the  voting  right  at  the  stockholders'  meetings. 
In  others  the  stock  has  not  passed  outright  into  the 
hands  of  the  supposed  owner,  but  is  merely  his  while 
he  remains  an  employee  of  the  company. 

It  would  seem  that  in  all  the  schemes  of  profit  sharing 
there  is  a  distinct  idea  that  increased  profits  would  be 
made  by  the  introduction  of  the  system.  It  is  sup- 
posed to  lead  to  increased  effort  on  the  part  of  the 
workmen,  while  in  a  great  many,  though  by  no  means 
all,  cases,  the  workman  is  compelled  to  remain  in  the 
employ  of  the  company  on  pain  of  losing  his  accumu- 
lated profits. 

On  the  whole  it  may  be  said  that  profit  sharing  cannot 
be  judged  entirely  by  the  method  which  is  adopted.  In 
some  cases  a  real  effort  is  made  to  give  the  workman  a 
share  in  the  returns  received  by  the  company,  a  share 
additional  to  the  standard  rate  of  wages  which  he 
receives  as  a  minimum.  In  these  cases  an  attempt 
has  been  made  to  make  the  connection  between  work- 
man and  employer  a  little  more  human,  to  regard  the 
workman  as  a  partner  in  the  business  rather  than  as 
a  piece  of  fixed  capital,  easily  replaced.  In  other 
cases  the  criticism  that  the  profit-sharing  methods  are 
merely  union-breaking  schemes  is  fully  justified.  In 


394  AN   INTRODUCTION    TO    ECONOMICS 

one  English  scheme,  for  instance,  the  cash  which  a 
workman  received  at  the  end  of  the  year,  as  dividend 
upon  the  share  of  stock  which  was  his  portion  of  the 
divided  profits,  amounted  to  about  a  couple  of  dollars. 
The  share  belonged  to  him  as  long  as  he  stayed  with 
the  company  and  it  was  given  to  his  heirs  if  he  died. 
Should  he  leave  the  employ,  however,  he  forfeited  his 
share.  Practically,  therefore,  if  he  wished  to  retain 
his  freedom  to  go  to  a  different  job,  the  actual  amount 
received  in  return  for  his  increased  effort  was  about 
two  dollars  a  year. 

At  best  profit  sharing  does  not  answer  the  criticism 
that  the  wealth  produced  is  not  equitably  distributed. 
It  is  a  palliative  of  the  existing  distributive  evils.  It 
depends  entirely  upon  the  will  of  the  individual  em- 
ployer or  company  both  for  its  institution  and  for  its 
method. 

In  the  actual  application  of  the  various  forms  of 
profit  sharing  the  success,  both  from  the  laborer's 
point  of  view  and  from  the  employer's,  has  varied 
very  greatly.  The  majority  of  the  attempts  have 
been  given  up.  Of  the  remainder  some  exist  in  theory 
only.  Where  a  certain  rate  per  cent  is  demanded  as  a 
preliminary  share  for  capital,  and  the  earnings  barely 
suffice  to  pay  this  rate,  obviously  there  can  be  nothing 
to  share  with  the  workers.  The  scheme  may  be  good, 
but  it  is  simply  inoperative. 

Judging  from  past  experience  it  may  be  said,  in  sum- 
ming up  our  discussion,  that  individual  types  in  individ- 
ual cases  have  been  successful,  but  as  a  system  profit 
sharing  has  failed  from  whatever  standpoint  it  be 
regarded. 


DISTRIBUTION   AND    THE    LABOR   PROBLEM     395 

Co-operation  —  The  second  criticism  of  existing 
economic  organization  is  that  the  workman  has  no 
share  in  the  control  of  his  work.  To  remedy  this  it 
has  been  suggested  that  he  gain  the  control  by  the 
establishment  of  industries  co-operatively  owned  and 
managed,  and  we  have  the  co-operative  systems  offered 
as  the  antidote  to  the  evil. 

Co-operation,  however,  may  be  regarded  from  two 
standpoints.  Omitting  all  consideration  of  the  fact 
that  in  order  to  have  anything  like  success  in  any 
organization  there  must  be  co-operation  between  the 
various  members  of  the  organization,  the  co-operative 
systems  may  be  considered  from  the  point  of  view 
of  co-operating  consumers  and  co-operative  producers. 
The  form  in  which  the  co-operative  ideas  as  translated 
into  practice  have  had  the  greatest  success  is  that  of 
consumers'  co-operation.  The  idea  first  arose  with  the 
establishment  of  a  little  co-operative  society  in  Roch- 
dale, a  Lancashire  cotton  town.  The  aim  of  the 
Rochdale  Pioneers  was  to  purchase  all  their  require- 
ments from  a  store  owned  and  operated  by  themselves. 
Each  of  the  members  subscribed  toward  the  small 
capital  of  the  society,  but  each  had  one  vote  and  one 
vote  only  in  the  management,  altogether  apart  from 
the  amount  of  capital  invested.  This  principle  has 
been  maintained  almost  invariably  with  co-operative 
societies.  The  idea  is  that  the  store  should  be  managed 
in  the  interests  of  all  without  distinction  in  regard  to 
individual  possessions.  The  organization  was  intended 
to  be  as  democratic  as  possible. 

Since  the  establishment  of  the  Rochdale  Pioneers  in 
1844  there  have  been  very  many  imitators  of  the 


396  AN    INTRODUCTION    TO    ECONOMICS 

system.  In  the  main  the  methods  of  operation  are 
similar,  no  matter  in  what  country  they  have  been 
conducted.  The  "  members  "  of  the  society  subscribe 
for  at  least  one  share  of  capital,  upon  which  they  receive 
a  dividend  limited  to  a  certain  sum.  The  society 
organizes  a  store  and  sells  goods  sometimes  only  to 
members,  sometimes  to  the  general  public  as  well.  The 
prices  charged  are  the  same,  or  nearly  so,  as  those 
charged  in  the  ordinary  privately  owned  stores.  The 
profits  of  the  society,  however,  over  and  above  the 
small  interest  on  the  capital,  are  divided  among  the 
purchasers  according  to  the  amount  of  their  purchases. 
In  some  cases  these  "  dividends  "  are  restricted  to  the 
members  of  the  society,  that  is,  to  those  who  hold  one 
or  more  shares.  In  others,  each  purchaser,  whether 
member  or  not,  is  entitled  to  receive  his  "  dividend  " 
at  the  end  of  the  accounting  period. 

Experience  has  taught  co-operators  in  all  countries 
that  these  small  co-operative  stores  are  largely  at  the 
mercy  of  the  wholesale  dealers.  The  latter  depend 
for  the  great  bulk  of  their  trade  upon  the  orders  received 
from  the  ordinary  privately  owned  stores.  A  little 
organization  among  these  stores  will  enable  them  to 
bring  pressure  to  bear  on  the  wholesalers  to  give  them 
discriminating  treatment.  Prices  to  the  co-operative 
stores  are  raised,  and  hence  profits  are  reduced  or 
actually  disappear. 

The  remedy  for  this  discriminating  treatment  is  to 
establish  co-operative  wholesale  stores.  In  this  case 
the  groups  of  co-operators  in  different  stores  combine  to 
establish  a  wholesale  store  which  will  deal  with  them 
alone  and  directly  with  the  manufacturers  of  the  goods 


DISTRIBUTION   AND    THE    LABOR   PROBLEM     397 

sold.  As  far  as  the  co-operators  in  England  are  con- 
cerned, and  the  system  has  made  great  headway  there, 
the  wholesale  difficulty  has  been  very  well  met  by  the 
establishment  of  the  Co-operative  Wholesale  Society, 
which  does  an  enormous  business  with  co-operative 
stores  throughout  the  country.  In  America  there  has 
not  been  anything  like  the  conspicuous  success  in  such 
co-operation  as  there  has  in  the  European  countries, 
for  reasons  which  will  be  mentioned  later. 

One  of  the  great  difficulties  which  these  co-operative 
stores  have  had  to  solve  is  that  of  efficient  management. 
It  does  not  pay  to  assume  that  any  one  can  keep  a  store. 
Yet  at  the  beginning  of  the  co-operative  movement  that 
was  the  general  assumption.  In  the  Rochdale  society 
each  of  the  twenty-eight  members  took  turns  in  "  mind- 
ing the  shop  "  and  in  keeping  the  simple  accounts  of  the 
store.  As  the  movement  developed,  case  after  case  of 
failure  was  seen  to  be  due  to  this  amateur  management, 
and  in  Europe,  at  any  rate,  co-operators  have  realized 
that  management  of  a  retail  store  calls  for  qualities 
and  knowledge  which  are  not  common  property. 
Hence  the  modern,  well-organized  co-operative  store 
is  managed  by  expert  retailers.  As,  however,  paid 
salesmen  and  managers  have  to  be  obtained,  the  diffi- 
culty arose  as  to  the  status  of  these  men  in  the  co- 
operative scheme.  In  some  cases,  the  co-operators 
have  not  recognized  their  employees  as  being  in  any 
way  partners  in  the  organization,  but  have  hired  them 
in  exactly  the  same  way  as  a  commercial  corporation. 
In  others  the  employees  have  been  shareholders  and 
therefore  had  a  right  to  a  vote  in  the  management. 
Co-operative  consumption  has  not  met  with  much 


398  AN   INTRODUCTION   TO   ECONOMICS 

success  in  the  United  States.  The  reasons  for  this  are 
various.  In  the  first  place  co-operation,  to  be  successful, 
demands  a  certain  amount  of  loyalty  to  the  society  — 
a  sinking  of  the  individual  in  the  common  organization. 
This  is  not  easy  to  obtain  in  America.  The  American 
is  almost  aggressively  individualistic.  He  is  accus- 
tomed to  rely  upon  himself,  and  if  for  a  while  he 
sees  that  it  would  pay  him  to  co-operate,  it  is  only 
for  a  while,  and  very  little  is  necessary  to  make  him 
give  up  the  organization.  Again  there  has  been  very 
little  community  of  action  between  the  co-operative 
societies  when  started.  There  has  been  no  state 
organization,  much  less  national  organization,  so  that 
co-operative  societies  in  one  part  of  the  country  could 
know  of  and  appreciate  the  work  done  by  others. 
With  this  lack  of  co-ordination  in  the  system  the  in- 
dividual societies  have  been  almost  entirely  at  the 
mercy  of  the  wholesale  dealers,  whose  largest  revenue 
came  from  the  privately  owned  establishments.  Hence 
discrimination  against  co-operators  became  easy,  and 
was  difficult  to  combat. 

Co-operative  Production  —  As  we  have  said,  co-opera- 
tive consumption  is  only  one  side  of  the  matter.  If 
co-operation  is  to  be  really  successful  and  to  become 
an  important  element  in  our  economic  organization,  it 
must  not  be  confined  to  consumption.  Production, 
also,  must  be  attempted.  It  is  in  the  realm  of  co- 
operative production  that  the  most  dismal  failures  have 
been  seen.  Occasionally  we  see  a  success  in  this  line, 
but,  as  a  rule,  the  result  is  more  or  less  qualified  failure. 

Capital  has  almost  always  been  too  small  to  permit 
of  the  introduction  of  the  best  methods.  We  have 


DISTRIBUTION   AND    THE    LABOR   PROBLEM     399 

seen  in  an  earlier  chapter  that  in  the  establishment  of 
productive  businesses  (using  the  word  productive  in 
its  ordinary  colloquial  meaning)  the  tendency  is 
strongly  toward  the  increase  of  the  amount  of  fixed 
capital  required.  Usually  this  means  a  certain  period 
of  waiting  before  results  may  be  obtained  which  may 
be  regarded  as  profits.  The  average  co-operator, 
especially  in  America,  is  strongly  inclined  to  be  im- 
patient. Hence  there  is  no  chance  of  the  industry 
being  successful.  Returns  cannot  be  gained  imme- 
diately. If  the  machinery  is  not  of  the  best  and  latest 
models,  the  products  are  obtained  at  a  disadvantage 
which  means  that  even  when  profits  are  made,  they 
are  smaller  than  those  of  industries  working  under  more 
favorable  conditions.  The  co-operative  producing  or- 
ganization tends  to  exist  near  the  margin  of  operation. 
A  little  fall  in  the  returns,  and  the  profit  line  is  over- 
stepped. 

Competition  from  the  better  organized  factories,  then, 
can  easily  force  the  co-operator  below  the  profit  line 
and  then  the  end  is  not  far  off. 

No  space  can  be  spared  to  give  instances  of  co- 
operative management,  but  a  word  or  two  as  to  the 
relation  between  co-operation  and  the  competitive 
system  will  be  of  value.  Co-operation,  as  it  has  been 
practiced,  accepts  the  competitive  system.  It  fixes 
its  prices  on  the  same  basis  that  they  are  fixed  in 
ordinary  commercial  life,  i.e.,  where  there  is  a  possi- 
bility of  gaining  a  monopoly  price,  that  price  is  charged, 
but  where  the  price  is  fixed  by  the  more  or  less  free 
interplay  of  the  laws  of  supply  and  demand,  the  co- 
operators  accept  that  price.  Experience  has  taught 


400  AN   INTRODUCTION   TO   ECONOMICS 

them  that  under  present  conditions  this  has  been  the 
best  method  to  pursue.  At  times  the  experiment  of 
selling  at  cost  (cost  to  include  expense  of  management) 
has  been  tried.  Almost  invariably,  however,  it  has 
been  seen  that  where  it  was  possible  to  charge  thus, 
the  purchasers  were  not  so  pleased  as  when  they  paid 
the  ordinary  price  and  received  a  dividend.  In  most 
cases,  however,  it  was  impossible  to  charge  thus.  For 
instance,  under  careful  calculation  the  cost  of  a  pound 
of  butter  might  amount  to  thirty-seven  and  one  half 
cents.  The  selling  price,  therefore,  had  to  be  at  least 
(on  individual  pounds)  thirty-eight  cents,  or  there 
was  a  loss.  Exaggerate  this  by  applying  it  to  all 
the  commodities  stocked,  and  consider  the  difficulty 
of  estimating  the  exact  share  of  overhead  expense 
and  expense  of  selling  of  one  commodity  and  another, 
and  the  very  great  difficulty  of  instituting  a  cost  price 
becomes  obvious. 

Experience  has  also  taught  co-operative  consumers' 
associations  that  the  purchasers  were  very  interested 
in  dividends  ("  divvy-hunters  "  is  a  common  expres- 
sion among  English  co-operators)  and  did  not  object 
even  to  an  increase  over  the  ordinary  commercial 
price,  provided  good  dividends  were  paid.  If  attention 
is  paid  to  the  dividend  alone,  the  system  merely  becomes 
one  of  compulsory  saving,  and  ceases  to  have  any  of 
the  real  benefits  assumed  to  arise  out  of  co-operation. 

As  there  seems  to  be  no  possibility  of  the  co-operative 
system  obtaining  a  strong  hold  on  America,  or  indeed, 
on  the  European  countries,  it  is  not  worth  while  to 
examine  the  result  to  be  expected  should  the  system  be 
extended  to  cover  all  industry  and  to  eliminate  all 


DISTRIBUTION   AND   THE   LABOR  PROBLEM    401 

competition.  Co-operation  is  not  a  scheme  for  a  re- 
organization of  the  commercial  system.  It  is  a  pallia- 
tive of  some  of  the  evils  of  competition.  As  such  it  has 
its  uses,  but  it  is  in  no  way  to  be  regarded  as  a  solution 
of  the  difficulty. 

Equality  of  Taxation  —  The  third  criticism  which  is 
leveled  at  the  existing  distribution  of  wealth  is  to  the 
effect  that  the  contributions  paid  toward  the  expenses 
of  government  are  not  properly  shared.  The  science  of 
taxation  is  very  complicated,  and  we  are  compelled  by 
reasons  of  space  to  restrict  our  consideration  of  this 
subject  to  the  smallest  compass. 

We  assume  that  government  must  exist.  There  is  no 
possibility  of  a  great  mass  of  people  existing  together 
unless  they  agree  upon  rules  of  conduct,  and  provide 
means  for  enforcing  those  rules.  There  are  some  forms 
of  economic  activity  which  are  essential  to  the  well- 
being  of  all,  but  which  are  not  usually  carried  on  by 
private  individuals.  Questions  of  police,  of  sanitation, 
of  justice,  of  the  safekeeping  of  the  roads  and  of  the 
seas  are  all  of  great  importance,  but  no  one  would 
expect  a  private  individual,  acting  under  the  com- 
petitive system,  to  erect  a  lighthouse  at  his  own  expense, 
without  the  privilege  of  collecting  a  toll  from  passing 
ships.  Nor  would  we  expect  him  to  pay  a  judge  to 
administer  justice,  unless,  indeed,  he  expected  that 
judge  to  see  the  law  from  the  point  of  view  of  the 
interest  of  his  employer.  Without,  at  present,  going 
into  the  functions  of  government,  it  is  sufficient  to 
assume  its  necessity.  The  question  then  arises  of  the 
payment  of  the  expenses  of  government.  Under  what 
basis  should  they  be  distributed? 


402  AN   INTRODUCTION   TO   ECONOMICS 

Should  landowners  only  be  taxed,  and  if  so,  how 
much?  Should  corporations  pay  a  share,  and  if  so, 
should  it  be  based  upon  their  capitalization  or  upon 
their  profits?  Should  the  incomes  of  all  be  used  as  a 
basis  of  taxation  ?  These  and  many  other  questions 
must  be  solved.  We  cannot  go  into  all  of  these 
questions,  but  some  of  the  principles  which  underlie 
their  solution  can  be  discussed. 

In  the  first  place  we  must  distinguish  two  points  of 
view.  The  secretary  of  the  treasury  or  chancellor  of 
the  exchequer,  or  whatever  name  may  be  given  to  the 
individual  responsible  for  the  proposal  of  taxation, 
has  one  distinct  point  of  view.  He  must  decide  how  he 
can  get  the  largest  amount  of  tax  revenue  and  how  he 
can  obtain  this  with  the  least  opposition.  The  tax- 
payer, on  the  other  hand,  is  interested  in  having  his 
own  individual  share  reduced  as  low  as  possible,  or  at 
least,  if  he  is  a  little  more  altruistic  than  the  ordinary 
person,  he  wants  the  taxes  to  be  distributed  so  that 
the  burden  falls  upon  the  back  best  able  to  bear  it. 

It  is  generally  assumed,  nowadays,  that  the  burden 
should  be  placed  where  it  can  most  easily  be  borne, 
rather  than  equally.  Equality  of  sacrifice  is  sought, 
rather  than  equality  of  amount  in  taxation.  This  is 
extremely  important  in  deciding  on  the  imposition  of 
direct  taxes,  such  as,  for  instance,  the  income  tax. 
Suppose  a  straight  tax  of  five  per  cent  were  made  upon 
all  incomes.  From  the  arithmetical  point  of  view  that 
would  be  a  fair  method.  But  it  is  not  so  from  the  more 
human  point  of  view,  which  takes  into  account  the 
sacrifice  involved.  Five  per  cent  of  a  wage  amounting 
to  $1000  per  annum  means  a  payment  of  $50.  Five 


DISTRIBUTION   AND    THE    LABOR   PROBLEM     403 


per  cent  of  a  salary  of  $50,000  per  annum  is 
The  sacrifice  of  $2500  by  the  man  with  the  large  income 
is  hardly  felt.  One  cannot  think  that  he  will  give  up 
anything  of  importance  through  the  diminution  of  his 
income.  On  the  other  hand  the  man  who  pays  50  dollars 
out  of  an  income  of  1000  dollars  feels  very  keenly  the 
loss  of  the  money.  His  sacrifice  is  very  much  greater 
than  that  of  the  wealthier  man. 

The  same  thing  is  true  of  taxes  levied  not  directly, 
but  on  commodities.  The  man  whose  income  is  only 
sufficient  to  supply  him  with  the  bare  requisites  of  life 
is  bound  to  feel  very  severely  anything  which  tends 
to  increase  the  cost  of  those  requisites,  while  the 
wealthier  man  feels  them  very  slightly  if  at  all. 

It  is  sometimes  argued,  too,  that  taxes  are  the  pay- 
ment made  for  a  definite  service  rendered  by  govern- 
ment—  services  like  the  securing  of  liberty,  the  pre- 
vention of  theft,  the  provision  of  sanitary  cities,  the 
care  of  the  sick  in  public  hospitals,  the  protection  of  the 
country  against  enemies.  As  all  are  supposed  to  be 
equally  benefited  by  these  services,  the  payment  from 
each  should  be  equal.  Against  this,  however,  it  is 
urged  that  the  services  are  not  the  same  to  each.  To 
the  poor,  whose  property  is  nothing,  the  protection 
against  theft  is  of  slight  importance,  while  it  is  of 
great  importance  to  the  man  of  property.  Hence 
as  the  service  is  greater  to  the  latter,  he  should  pay 
more. 

Again,  some  of  the  services  are  distinctly  personal. 
For  example,  the  machinery  which  safeguards  patent 
rights  for  inventors  affects  only  the  inventors.  They 
should  be  required  to  pay  for  those  services  much  as  the 


404  AN    INTRODUCTION   TO    ECONOMICS 

person  who  rides  in  a  municipal  street  car  is  made  to 
pay  for  the  service  rendered. 

In  actual  practice  a  compromise  is  effected  by  the 
tax  makers.  In  some  cases  a  specific  charge  is  made 
for  the  services  rendered  by  the  state.  This  class  of 
tax  is  usually  referred  to  as  a  fee,  and  comes  under 
the  same  category  as  a  fee  charged  by  a  doctor  or 
lawyer.  In  others,  the  tax  is  laid  directly  upon  the 
commodity,  like  the  tax  on  tobacco,  for  example.  In 
this  case  each  pays  in  proportion  to  the  amount  of  the 
commodity  he  uses. 

As  a  matter  of  reform  in  the  distribution  of  wealth, 
it  is  doubtful  whether  improvement  in  tax  methods 
can  be  of  any  great  service.  It  is,  of  course,  true  that  a 
great  deal  of  injustice  can  be  effected  by  changes  in 
the  method  of  obtaining  government  revenue,  but  their 
proportional  effect  upon  distribution  can  be  very  much 
overestimated.  In  exceptional  times,  of  course,  there 
is  opportunity  for  the  government  to  obtain  a  greater 
share  from  certain  individuals  than  in  normal  times. 
In  the  case  of  war  time,  for  example,  we  have  an 
unusual  situation  where  men  in  certain  businesses  have 
reaped  very  great  profits  through  the  sudden  increase 
in  demand  for  the  commodities  they  manufacture. 
Steel  manufacturers,  munitions  makers,  clothing  con- 
tractors, and  each  of  the  thousand  and  one  different 
trades  which  are  affected  by  war  requirements,  have 
been  able  to  make  enormous  profits.  As  these  profits 
are  directly  a  charge  on  the  general  community,  a 
charge  due  to  the  fact  that  the  manufacturers  concerned 
have  taken  direct  advantage  of  the  government's 
needs  to  increase  their  prices,  the  government  is 


DISTRIBUTION   AND    THE    LABOR   PROBLEM     405 

certainly  entitled  to  take,  if  not  all  the  additional  profit 
above  normal  rates,  at  any  rate  the  greater  proportion. 
Hence  we  see  the  institution  of  the  excess  profits  tax, 
which  levies  toll  upon  these  abnormal  profits.  Heavy 
as  has  been  the  taxation  on  this  basis,  it  cannot  be  said 
to  have  been  too  heavy  and  no  one  has  worried  much 
about  the  opposition  of  certain  interests  to  the  im- 
position or  increase  of  such  taxation. 

Under  the  present  system  of  economic  organization, 
where  distribution  is  obviously  unequal  and  inequitable, 
there  can  be  no  doubt  that  the  basis  of  equality  of 
sacrifice  is  the  best  upon  which  to  work  in  securing 
the  funds  necessary  for  the  support  of  government. 
Equality  of  sacrifice  in  taxation  necessitates  what  may 
be  called  progressive  taxation.  Taxation  is  pro- 
portional when  the  rate  levied  varies  arithmetically 
with  the  amount  to  be  taxed.  That  is,  when  the  same 
percentage  is  charged  no  matter  how  high  the  amount 
be,  the  taxation  is  proportional.  But  we  have  already 
seen  that  merely  proportional  taxation  is  not  satis- 
factory in  securing  equality  of  sacrifice.  Hence  in 
direct  taxation,  particularly  in  regard  to  income  taxes, 
the  best  method  is  to  increase  the  percentage  paid  as 
the  amount  of  income  increases.  It  is  impossible  to 
estimate  mathematically  how  the  taxation  should  be 
graded,  for  each  man's  income  has  special  considerations 
which  require  to  be  regarded.  Some  men  gain  great 
incomes  by  their  own  exertions  —  successful  lawyers, 
doctors,  actors,  manufacturers,. for  instance.  Others 
sit  still  and  do  nothing  but  draw  dividends.  In  the 
latter  case,  seeing  that  no  duties  are  performed  by  the 
individuals  in  question,  it  is  right  that  they  be  called 


406  AN   INTRODUCTION   TO   ECONOMICS 

upon  to  pay  pretty  heavily  for  their  support  in  idleness. 
In  regard  to  the  others,  they  are  at  least  supplying  some 
demand  directly,  and  in  so  far  they  are  deserving  of 
encouragement  by  the  community.  This  leads  us  to 
the  distinction  between  earned  and  unearned  incomes, 
the  latter  being  taxed  at  a  heavier  rate. 

As  has  been  said,  however,  the  distribution  of  wealth 
will  hardly  be  materially  affected  by  reforms  of  taxation 
while  the  taxation  is  levied  with  the  pure  aim  of 
securing  sufficient  and  only  sufficient  revenue  to  run 
the  government  of  the  country.  A  much  more  im- 
portant suggestion  is  a  revolution  of  the  ideas  as  to  the 
economic  functions  of  government.  As  a  great  many 
of  the  schemes  of  economic  reorganization  are  based 
upon  such  a  fundamental  revision  of  our  ideas  on 
these  functions,  it  will  be  well  to  leave  their  con- 
sideration to  the  next  chapter. 


CHAPTER  XXIX 

THE  ECONOMIC  FUNCTIONS   OF   GOVERNMENT 

Most  of  the  theories  upon  which  are  based  the  pro- 
grams for  redistribution  of  wealth  have  their  origin 
in  the  belief  that  the  economic  system  under  which  we 
live  at  present  is  wrongly  founded.  The  suggestions 
which  have  been  discussed  in  the  previous  chapter  are 
considered  as  mere  tinkering  with  the  organization, 
when  what  is  required  is  a  thorough  rebuilding  upon  a 
new  foundation. 

In  nearly  every  case  the  suggestions  for  the  new 
foundation  of  economic  society  include  a  very  con- 
siderable increase  in  the  economic  functions  of  govern- 
ment. It  will  be  well,  therefore,  before  we  can  deal 
properly  with  the  schemes  of  social  and  economic  re- 
construction which  are  of  such  enormous  importance 
at  the  present  time,  to  analyze  carefully  the  economic 
functions  of  government  as  they  now  exist.  We  may 
divide  them  into  three  classes,  the  protective  func- 
tions, the  regulative  functions,  and  the  operative 
functions. 

Protective  Functions  —  Even  the  strongest  believer 
in  the  theory  of  laissez  faire  will  be  quite  willing  to 
admit  that  government  has  certain  duties  to  perform 
which  are  of  an  economic  nature.  Free  competition, 
which  is  essential  to  the  laissez  faire  system,  cannot 

407 


408  AN   INTRODUCTION   TO   ECONOMICS 

exist  unless  the  law  of  contract  is  made  effective. 
All  our  trade  depends  to  a  large  extent  upon  the  fact 
that  individuals  on  the  whole  are  ready  to  fulfill  their 
obligations  when  and  as  they  arise,  but  some  compul- 
sion must  be  exerted  upon  those  who  refuse  to  live  up 
to  these  obligations.  The  law  must  step  in  to  protect 
the  individual  against  those  who  receive  the  benefit 
of  one  part  of  the  contract  and  refuse  to  perform  the 
per  contra. 

Again  it  is  recognized  that  some  parties  to  contracts 
are  not  in  a  position  to  protect  themselves  against 
exploitation  by  others.  This  is  particularly  the  case 
in  labor  contracts.  Children  are  certainly  not  able  to 
secure  just  treatment  themselves.  If  their  parents 
force  them  to  work  before  they  are  really  strong  enough 
to  earn  their  own  living,  there  is  nothing,  except 
government  action,  which  can  prevent  their  exploitation 
successfully.  Child  labor  laws  are  essential  to  any  well- 
ordered  state.  But  child  labor  laws  only  represent 
the  beginning  of  the  government's  protective  work  in 
regard  to  labor.  Women's  labor  must  also  be  pro- 
tected, and  indeed  men's  labor  as  well.  There  was  a 
time  when  it  was  common  to  work  for  sixteen  or  more 
hours  per  day.  This  is  not  the  case  now.  Govern- 
ment has  stepped  in,  time  after  time,  to  restrict  the 
hours  of  labor.  Government  has  also  interfered,  and 
wisely  so,  in  the  manner  in  which  workshops  and 
factories  are  conducted.  Sanitary  laws  have  been 
passed,  as  also  have  laws  against  the  use  of  unfenced 
machinery,  unsafe  scaffoldings,  and  so  forth. 

The  general  security  of  the  country  against  foreign 
invasion  is  part  of  the  function  of  government.  This 


THE   ECONOMIC   FUNCTIONS   OF  GOVERNMENT    409 

is  comparable,  although  it  is  on  a  larger  scale,  with 
the  police  protection  afforded  the  individual  in  our 
cities. 

Our  ocean  trade  and  coast  trade  are  protected  by 
proper  mapping  of  the  harbors  and  sea  passages. 
Lighthouses  are  maintained  at  government  expense. 
It  is  obviously  impossible  to  expect  that  private  in- 
terest will  erect  and  maintain  lighthouses,  yet  they  are 
necessary  to  safe  trading. 

Regulative  Functions  —  The  history  of  government 
economic  activity  since  the  industrial  revolution  is  full 
of  examples  of  increase  in  the  regulative  functions  of 
government.  It  was  pointed  out  in  an  earlier  chapter 
that  a  distinct  change  has  taken  place  in  the  nature  of 
government  regulation,  however,  and  it  is  worth  while 
now  to  consider  the  change  in  some  detail.  The  theories 
of  economic  organization  to  which  the  name  of  laissez 
faire  has  been  attached,  were  very  largely  due  to  a 
reaction  against  the  old-fashioned  method  of  govern- 
ment regulation  of  trade  and  industry.  Such  regulation, 
consisting  as  it  did  in  laying  down  rules  for  the  conduct 
of  industry,  rules  which  were  to  guide  the  manu- 
facturers in  the  methods  to  be  used  in  industry  and  the 
products  to  be  manufactured,  was  felt  to  be  interference 
rather  than  regulation.  With  the  advent  of  the  new 
machine  production  the  irritating  interferences  of 
government  were  bitterly  resented. 

As  is  quite  often  the  case,  it  was  not  seen  at  the  time 
that  a  change  in  the  nature  of  government  regulation  of 
industry  was  required.  The  manufacturers  demanded 
the  entire  and  complete  abolition  of  all  regulation. 
Industry  was  best  when  it  was  left  most  alone ;  govern- 


410  AN   INTRODUCTION   TO   ECONOMICS 

ment  which  did  the  least  governing  was  the  best  form 
—  these  were  the  cries. 

Experience  soon  taught,  however,  that  government 
could  not  let  industry  alone.  That  selfishness  which 
was  supposed  to  be  the  foundation  of  successful 
economic  organization  showed,  in  practice,  that  it  had 
lost  little  of  its  ancient  evil.  While  it  did  secure  a 
wonderful  addition  to  the  total  wealth  of  the  country, 
it  succeeded  also  in  changing  the  relative  distribution 
to  an  enormous  extent.  The  strong  prospered  and  the 
weak  were  driven  to  the  wall.  Modern  feelings  of 
humanity  prevent  us  from  considering  that  the  weak 
are  better  killed  off.  We  realize,  and  should  realize 
even  more  strongly  than  we  do,  that  if  the  weak  were 
driven  off  and  society  consisted  only  of  the  strong,  the 
loss  would  be  to  society.  This  is  especially  so  when 
we  consider  economic  strength.  The  ability  to  make 
money  is  not  the  only  ability  of  which  society  stands 
in  need.  This  is  obvious  if  one  considers  for  a  moment 
what  life  would  be  like  if  every  one  of  us  devoted  his  or 
her  attention  solely  to  the  purpose  of  gaining  as  much 
wealth  as  possible.  Our  music  would  degenerate  into 
rag-time,  our  artists  into  poster  painters,  and  our 
actors  into  "  movie  artists."  We  are  not  decrying 
any  of  these  forms  of  self-expression,  of  course,  but  it 
must  be  admitted  that  much  of  the  best  of  life  would 
be  lost  if  money  were  the  only  consideration. 

In  order  to  prevent  a  crude  conception  of  economic 
organization  from  ruining  the  world,  government  had  to 
step  in  to  regulate  the  working  of  the  system.  It  has 
been  shown  in  the  previous  pages  that  the  tendency  of 
economic  development  is  towards  the  elimination  of 


THE   ECONOMIC   FUNCTIONS   OF   GOVERNMENT    411 

competition.  But  while  that  tendency  exists  to  a  very 
strong  degree  there  exists  at  the  same  time  a  strong 
tendency  for  the  control  of  the  larger  units  which  have 
superseded  the  small  competitive  units,  to  pass  into 
the  hands  of  a  comparative  few  whose  main  idea  is  not 
the  service  of  the  public,  but  the  gaining  of  profit. 

Large-scale  production  undoubtedly  secures  economy 
of  effort  in  production,  but  that  economy  is  of  no  real 
benefit  to  society  unless  society  as  a  whole  shares 
in  the  profits.  The  dangers  of  powerful  monopolies, 
controlled  by  individuals  whose  concern  is  merely 
profit  making,  are  obvious  and  there  is  no  need  to  labor 
the  point.  Government  must  step  in  to  see  that  the 
monopolies  or  quasi-monopolies  are  so  conducted  that 
benefit  and  not  loss  results  to  society. 

It  is  for  this  reason  that  we  have  our  railroad  com- 
missions and  interstate  commerce  commissions  —  our 
anti-trust  laws  and  bank  acts.  A  point  is  reached, 
however,  when  there  is  little  real  distinction  between 
control  and  ownership,  except  in  operation.  If  the 
trusts  are  so  controlled  that  they  cannot  manipulate 
prices  to  suit  themselves,  much  of  their  value  to  those 
who  have  organized  them  is  lost.  The  public,  however, 
is  benefited  by  the  economies  of  production,  provided, 
of  course,  that  the  trusts  have  been  organized  on  a 
sound  productive  basis.  But  if  the  government  does 
so  control  the  trusts,  and  profits  to  the  owners  sink  to 
the  level  of  commercial  interest,  the  trust  owners 
become  practically  shareholders  in  a  government 
organization. 

Again,  in  the  case  of  railroad  regulation  and  control, 
the  control  may  be  exercised  so  stringently  that  the 


412  AN    INTRODUCTION    TO    ECONOMICS 

railroad  owners  are  also  in  the  position  of  government 
bondholders. 

The  difficulty  has  been  to  decide  where  to  stop. 
It  is  not  our  intention  to  give  details  of  control  as 
exercised  by  our  government.  It  must  be  pointed  out, 
however,  that  there  are  certain  industries  which  are  of 
the  nature  of  monopolies.  They  cannot  be  successfully 
operated  unless  they  are  worked  on  a  very  large  scale. 
These  are  the  so-called  "  public  utilities."  Every  one 
recognizes  that  competing  telephone  systems  are  un- 
desirable. The  telephone  system  in  a  city  should  be  a 
unit,  not  two  or  three  units.  The  same  is  true  of  street 
car  service.  To  a  less  extent,  perhaps,  the  same  is  also 
true  of  railroads.  Two  railroads,  separately  conducted 
and  organized  and  following  the  same  routes,  are  uneco- 
nomical. For  this  reason,  these  public  utilities,  whether 
owned  by  the  public,  i.e.,  the  government,  or  privately 
owned,  must  be  permitted  to  work  as  monopolies. 

They  must  be  closely  controlled,  however,  in  order 
to  protect  the  right  of  the  public  as  against  the  rights 
of  the  individuals  who  own  the  stock  in  the  monopoly. 
At  present,  the  extent  of  the  regulation  depends  greatly 
upon  questions  of  practical  statesmanship.  This  mat- 
ter will  be  further  considered  later. 

Operative  Functions  —  The  student  will  have  realized 
that  the  regulative  functions  of  government,  carried 
to  extremes,  tend  to  overlap  into  the  operative.  There 
are,  however,  some  operative  functions  which  the 
governments  all  over  the  world,  practically,  retain  in 
their  own  hands.  The  outstanding  instance  is,  of 
course,  the  carriage  of  mails.  The  post  office  is  an 
institution  which  few,  even  of  the  most  rabid, 


THE    ECONOMIC   FUNCTIONS   OF   GOVERNMENT     413 

individualists  would  like  to  see  again  in  private  hands. 
We  seldom  realize  to  what  a  tremendous  extent  civi- 
lization depends  upon  the  free  and  cheap  carriage  of 
mails.  A  little  consideration,  however,  will  serve  to 
show  the  extreme  importance  of  this  function.  If  any 
industry  must  be  carried  on  as  a  monopoly  in  order 
to  serve  its  purpose  well,  it  is  this. 

The  supply  of  transportation,  however,  is  almost  as 
important.  Hence  it  is  in  this  instance  that  we  find  the 
next  most  common  of  the  operative  functions.  It  is 
true  that  the  national  government  is  not  so  usually 
concerned  as  the  municipal.  But  the  fact  that  trans- 
portation within  the  confines  of  a  city  tends  more  and 
more  to  become  the  care  of  the  civic  authorities  does 
not  take  away  from  the  governmental  nature  of  the 
operation.  There  are  few  cases,  moreover,  where  the 
cities  which  have  once  undertaken  the  management  of 
their  own  transportation  systems  have  relinquished  that 
management  into  the  hands  of  private  corporations. 

The  same  is  true  of  the  supply  of  water  and  of  light 
and  heat.  The  question  then  arises,  how  far  is  the 
governmental  function  of  operating  industries  either 
in  competition  with  or  in  supersession  to  private 
operation,  to  be  extended.  There  are  some  cities  that 
run  their  own  electric  car  systems,  but  do  not  supply 
their  own  water.  Others  supply  their  own  water  but 
not  transportation.  Some  own  their  telephone  systems, 
but  not  their  gas  and  electricity.  In  some  countries 
the  government  owns  the  railways  entirely;  others 
have  both  government  and  privately  owned  railway 
systems ;  while  in  still  others  the  railway  systems  are 
privately  owned  and  operated. 


414  AN   INTRODUCTION   TO   ECONOMICS 

Government  or  Private  Ownership  of  Public  Utili- 
ties—  The  question  as  to  whether  public  utilities  should 
be  owned  by  the  public  themselves  or  by  private  in- 
terests is  one  which  cannot  be  given  a  general  answer ; 
so  much  depends  upon  the  individual  instance.  It  is 
important  to  remember,  however,  that  government 
itself  consists  only  in  the  relegation  to  certain  in- 
dividuals of  a  certain  amount  of  control  over  others. 
These  individuals  frequently  abuse  the  power  placed 
in  their  hands.  Frequently  they  make  grave  mistakes. 
To  take  hypothetical  instances,  we  may  say  quite 
definitely  that  where  the  government  consists  of  in- 
dividuals who  are  not  trusted  by  the  governed,  or 
where  they  are  notoriously  inefficient,  there  is  no 
question  but  that  public  utilities  should  remain  in 
the  hands  of  private  enterprisers.  Where,  on  the 
other  hand,  the  government  has  proved  itself  both 
honest  and  capable,  a  strong  case  is  made  out  for  the 
operation  of  public  utilities  by  the  governmental  or- 
ganization. 

It  is  well  to  remember,  too,  that  because  government 
has  failed  in  a  particular  case  to  give  a  good  account  of 
its  operations  that  is  no  argument  against  the  general 
case  for  government  ownership  and  operation  of  public 
utilities.  In  a  recent  work  it  was  argued  that  because 
a  certain  government  had  failed  miserably  in  working 
a  telephone  system,  dishonesty  and  inefficiency  being 
evident  in  all  its  workings,  therefore  the  case  for  govern- 
ment ownership  of  telephones  was  entirely  lost.  As  a 
matter  of  fact,  however,  that  same  government  had 
shown  itself  utterly  incapable  of  administering  jus- 
tice with  the  least  degree  of  equity.  If  the  former 


THE   ECONOMIC   FUNCTIONS   OF   GOVERNMENT     415 

argument  held  good,  then  it  was  just  as  conclusively 
proved  that  law  and  order  should  be  in  private  hands. 

Private  enterprise  has  advantages  that  it  would  be 
absurd  to  underestimate.  With  profit  as  the  great  aim 
of  life,  a  vast  multitude  of  different  satisfactions  have 
been  produced.  The  fullest  development  of  the  in- 
dividual activity,  self-seeking,  has  made  possible  the 
sustenance  of  a  great  population.  Countries  which 
formerly  supported  with  difficulty  a  population  of  a 
few  millions  now  support  with  comparative  ease  many 
times  that  number.  During  the  past  hundred  years 
inventions  of  labor-saving  machinery  have  been  million- 
fold;  so  also  have  inventions  to  satisfy  our  aesthetic 
senses.  Men  have  expended  every  last  ounce  of  energy 
they  have  possessed  in  the  service  of  their  fellows.  It  is 
not  true,  however,  that  they  have  always  realized 
this  service  and  have  taken  it  for  their  aim.  The 
service  has  been  incidental ;  but  it  nevertheless  existed, 
and  that  much  must  be  granted  to  the  individualistic 
system  of  private  enterprise. 

Lessons  of  the  War  —  A  system  is  not  properly  tested 
in  normal  times,  however.  It  must  stand  the  strain 
of  a  crisis  before  we  can  say  that  it  is  really  successful. 
At  the  present  time,  we  are  in  the  midst  of  one  of  the 
greatest  crises  in  the  history  of  the  world.  The  great 
war  is  practically  ended,  and  we  cannot  afford  to  be 
blind  to  the  lessons  which  it  has  taught  us.  It  is  not 
within  the  scope  of  our  study  to  inquire  into  the  moral 
aspects  of  war  or  into  the  political  causes  and  results. 
War,  however,  is  very  largely  an  economic  problem, 
especially  when  it  is  on  a  large  scale.  The  colossal 
scale  upon  which  the  great  war  has  been  waged  has 


416  AN   INTRODUCTION   TO   ECONOMICS 

put  an  enormous  strain  upon  our  economic  organization. 
In  the  first  place  it  has  meant  the  withdrawal  from 
productive  labor  of  a  very  large  section  of  the  popu- 
lation of  the  belligerent  countries.  Probably  over 
thirty -five  million  men  have  been  engaged  in  actual 
fighting.  Add  to  these  the  great  number  who  have 
been  more  or  less  intimately  connected  with  purely  war 
production  and  we  enormously  increase  the  total 
number  of  those  whose  labors  are  non-productive  for 
ordinary  purposes. 

Meanwhile,  of  course,  the  remainder  of  the  population 
must  produce  all  the  necessaries  of  life,  not  only  for 
themselves  but  for  those  who  are  withdrawn  from  ordi- 
nary production.  Normally  we  may  assume  that,  on 
the  average,  each  produces  enough  for  his  support 
and  for  the  support  of  his  dependents.  Now  a  much 
smaller  number  must  labor  to  supply  all  the  needs. 
But  production  cannot  be  maintained  at  a  constant 
level  during  war  time.  If  the  war  is  to  be  successfully 
waged,  production  must  be  increased  because  of  the 
enormous  waste  of  material,  a  waste  which  is  infinitely 
greater  than  that  of  ordinary  life. 

Such  a  situation  places  a  tremendous  strain  upon  the 
economic  organism.  If  it  has  been  inefficient  before, 
but  the  inefficiency  has  not  been  very  evident,  it  will 
appear  at  once  with  the  new  strain.  At  the  outbreak 
of  the  war  it  was  quite  obvious  that  without  great 
changes  the  economic  structure  must  break  down.  The 
first  indications  lay  in  th£  financial  world.  We  have 
already  noted  that  finance  is  peculiarly  sensitive  to 
economic  disturbances.  The  methods  of  financing 
international  trade  are  complicated  and  require  a 


THE    ECONOMIC    FUNCTIONS    OF   GOVERNMENT      417 

very  considerable  amount  of  trust  in  the  fulfillment  of 
promises.  Now  in  war  time  some  of  these  inter- 
national contracts  simply  cannot  be  fulfilled.  Ships  are 
required  for  the  transport  of  men.  When  the  enemy 
resorts  to  indiscriminate  destruction  of  merchant 
ships  the  loss  of  transport  facilities  is  very  much  greater. 
Without  government  assistance  the  whole  structure  of 
our  international  payment  system  would  have  broken 
down.  Acceptances  could  not  be  met  at  maturity. 
Exchanges  were  subject  to  rapid  fluctuations  much 
wider  than  in  ordinary  times.  Organized  co-operation 
was  essential  unless  an  epidemic  of  bankruptcies  was 
to  ensue.  Hence  almost  at  the  very  outbreak  of  the 
war,  we  find  government  after  government  taking 
steps  to  prevent  these  bankruptcies.  It  is  impossible 
within  the  limits  of  the  present  book  to  enter  into 
details  as  to  the  methods  adopted  in  one  country 
or  another.  The  principle  which  we  wish  to  emphasize, 
however,  is  clear.  Private  enterprise,  relying  very 
largely  upon  the  competitive  system,  succeeds  fairly 
well  in  normal  times,  but  in  a  crisis,  all  must  realize 
the  intimate  interdependence  of  society,  and  organized 
co-operation  must  be  substituted  for  the  working  of  a 
laissez  faire  system. 

It  is  not  in  the  financial  realm,  however,  that  the 
most  important  effects  of  war  upon  economic  structure 
are  seen.  It  is  in  the  realm  of  production.  The  whole 
basis  of  production  is  changed.  Under  a  system  of 
private  enterprise,  the  motive  for  production  is  not  the 
rendering  of  services.  The  services  must  be  rendered, 
of  course,  but  this  is  incidental.  The  real  motive  is 
the  gaining  of  profit  to  the  person  who  performs  the 


418  AN   INTRODUCTION   TO   ECONOMICS 

service.  Now  the  highest  profit,  as  we  have  seen,  does 
not  necessarily  mean  efficient  production  so  as  to  secure 
the  greatest  amount  with  the  least  effort.  With  a 
diminished  working  population  and  an  enormously 
increased  demand,  profit,  from  the  social  point  of 
view,  ceases  to  count.  What  is  required  is  a  vast 
increase  in  production  utilizing  every  known  means  of 
economizing  effort.  The  nation  could  not  afford  to 
let  private  individuals  take  the  opportunity  of  profiting 
by  the  peculiar  circumstances  which  caused  the  great 
increase  in  demand  for  goods  and  services. 

Let  us  take  one  of  the  principal  illustrations  of  the 
failure  of  uncontrolled  private  enterprise.  Our  rail- 
road system,  or  rather  our  railroad  systems,  have  on 
the  whole  shown  a  wonderful  power  of  organization,  but 
they  have  nevertheless  allowed  a  very  great  amount  of 
waste  effort.  Competitive  lines  running  between  the 
same  terminals  have  meant  uneconomic  terminal 
facilities,  unequal  distribution  of  freights,  and  when? 
the  two  lines  were  more  than  sufficient  for  the  traffic 
to  be  borne,  half  empty  trains  and  idle  freight  cars 
have  resulted.  Cars  have  often  passed  one  another, 
going  in  opposite  directions,  with  similar  goods.  All 
this  is  pure  waste  and  is  incidental  to  a  system  of 
private  enterprise.  This  waste,  however,  could  not 
be  suffered  under  the  crisis.  Hence  some  co-ordinating 
effort  had  to  be  made  to  eliminate  it.  Practically,  the 
only  way  was  that  which  was  actually  adopted.  The 
government  took  entire  control  of  the  railways.  Every 
available  car  was  used,  and  all  cross-shipments  pre- 
vented as  far  as  possible.  If  the  government,  however, 
had  merely  assumed  control  of  the  railways,  without 


THE   ECONOMIC   FUNCTIONS   OF   GOVERNMENT      419 

at  the  same  time  controlling  production,  much  of  the 
possible  economy  would  have' been  missed.  Possibly 
the  best  way  in  which  the  whole  operation  of  govern- 
ment control  and  organization  can  be  seen  is  to  take  as 
an  illustration  the  building  of  a  merchant  fleet  under 
government  contract. 

Illustration  of  Government  Economic  Activity  during 
the  War  —  At  the  outbreak  of  the  war  the  American 
merchant  marine  was  almost  a  negligible  quantity. 
The  British  owned  far  more  ships  than  any  other 
country,  and  while  a  good  deal  of  British  shipping  was 
used  to  transport  foodstuffs  and  munitions  of  war  from 
the  United  States,  this  shipping  was  in  great  demand 
for  purely  British  purposes.  More  ships  were  abso- 
lutely necessary  to  carry  on  the  normal  trade,  let 
alone  the  abnormal  demands  of  the  war  period.  The 
facilities  for  building  ships  in  this  country,  while 
sufficient  for  previous  needs,  were  entirely  inadequate 
for  the  construction  of  enough  vessels  to  satisfy  the 
new  demands. 

The  United  States  government,  therefore,  decided 
to  build  its  own  ships.  It  financed  the  existing  ship- 
building companies  so  that  they  could  extend  their 
yards.  It  provided  much  of  the  funds  necessary  to 
build  new  yards.  Contract  after  contract  was  let  for 
the  construction  of  ships,  the  total  amount  involved 
being  several  hundred  million  dollars.  Not  only  did 
the  government  let  the  contracts;  it  undertook  to 
provide  the  steel  necessary  and  the  wood  also,  where 
the  ships  were  built  of  wood.  All  orders  for  material 
of  any  nature  required  in  the  construction  of  the 
ships  —  boilers,  machinery,  anchors,  chains,  cable, 


420  AN   INTRODUCTION   TO   ECONOMICS 

steel  —  were  centralized.  And  it  was  here  that  the 
control  of  the  railways  played  such  an  important  part. 
The  steel  and  other  materials  were  sent  from  the  nearest 
manufacturing  point  to  the  place  where  they  were 
needed.  The  orders  were  so  placed  that  as  far  as 
possible  each  ship-builder  had  sufficient  material  for 
his  immediate  needs,  without  laying  in  a  great  stock. 
Thus  no  ships  were  provided  with  machinery  long  before 
the  machinery  could  be  installed  in  the  vessel,  while 
others  lacked  machinery  and  were  delayed  in  construc- 
tion. As  far  as  was  possible  in  such  a  rapidly  con- 
structed organization,  every  available  means  was 
adopted  to  secure  the  whole  of  the  ship  construction 
program  working  as  one  unit. 

This  system  would  have  been  quite  impossible  with- 
out the  government  organization.  It  would  have  been 
extremely  difficult  for  the  individual  concerns  to  have 
organized  themselves  on  such  a  basis  that  each  of  them 
received  all  that  it  required  and  as  it  was  required. 
Under  private  enterprise  each  would  have  sought  to  fill 
his  requirement  for  as  long  a  future  period  as  possible, 
regardless  of  the  fact  that  others  might  have  to  delay 
construction  of  ships  until  necessary  material  could  be 
obtained. 

The  contractors  were  left  very  largely  to  themselves 
in  the  matter  of  construction,  although  government 
inspection  of  every  part  of  the  ships  was  secured. 
That  there  was  a  considerable  amount  of  waste  and 
some  duplication  of  effort  is  undoubtedly  true.  This, 
however,  was  inevitable  under  the  circumstances. 
The  object  was  to  produce  ships  as  quickly  as  possible 
and  regardless  of  the  cost.  No  one  can  deny  that  this 


THE   ECONOMIC   FUNCTIONS   OF   GOVERNMENT      421 

object  was  fully  achieved.     It  was  only  possible  to 
achieve  it,  however,  under  government  organization. 

Now  let  us  summarize  the  difference  between  the  old 
private  system  and  the  new  government  organization. 
Under  the  old  system  we  had  fairly  efficient  single 
organizations  competing  with  one  another,  but  no 
co-ordination  of  general  effort.  Under  the  new,  while 
there  was  no  doubt  a  considerable  amount  of  inefficient 
work,  there  was  distinct  co-ordination  of  general  effort. 
Waste  there  was,  too,  but  the  waste  was  due  rather  to 
the  extreme  haste  with  which  all  construction  had  to 
be  carried  on.  But  waste  existed  also  under  the 
older  system.  In  fact  it  would  be  safe  to  say  that  there 
was  greater  waste  in  the  competitive  method  than 
in  the  new  co-operative  method.  To  counterbalance 
the  waste  there  was  a  great  economy  of  productive 
effort.  This  was  bound  to  be  the  case  when  the  aim  of 
production  was  changed  from  the  mere  securing  of 
profit  to  the  increasing  of  the  amount  produced.  In 
short,  left  to  itself  the  private  enterprise  could  not 
have  produced  the  American  Merchant  Marine  which 
has  been  developed  in  the  brief  space  of  one  and  a 
half  years  by  the  United  States  Shipping  Board. 

It  is  not  only  in  the  line  of  production,  however,  that 
government  had  to  take  on  new  duties.  Scarcity  of 
foodstuffs  and  materials  generally  made  it  necessary 
to  ration  these  to  consumers.  We  all  know  how  the 
government  restricted  the  individual  use  of  sugar, 
wheat,  and  other  foods.  We  know  also  that  the 
makers  of  clothing  materials  were  restricted  in  the 
amount  of  wool  that  they  could  use.  It  is  not  so  well 
known,  however,  that  in  other  countries  (in  England, 


422  AN    INTRODUCTION   TO    ECONOMICS 

for  example)  practically  every  manufacture  was  super- 
vised to  the  extent  that  the  raw  material  was  rationed 
out  among  the  manufacturers.  Instead  of  competing 
with  one  another  for  the  use  of  the  raw  materials,  each 
received  a  share  according  to  his  capacity  to  use  it. 
American  wheat  was  practically  rationed  out  to  the 
European  countries  who  were  too  occupied  with  actual 
fighting  to  produce  their  necessary  food.  It  is,  indeed, 
probable  that  for  a  long  time  such  regulation  of  food 
importations  will  have  to  be  maintained. 

At  the  present  moment  we  are  not  concerned  with 
the  question  whether  this  government  rationing  is 
the  right  method  or  not.  All  that  we  are  trying  to 
show  is  that  in  a  time  of  national  crisis,  the  system  of 
private  enterprise  must  give  place  to  government 
control  and  in  many  cases  government  operation  also. 

One  lesson  we  have  learned  from  the  experiments 
conducted  during  the  war  —  a  lesson  which  will  have 
extremely  important  influences  upon  the  economic 
organization  of  the  future.  In  spite  of  the  efficiency 
which  has  characterized  industry  all  over  the  world, 
and  American  industry  in  particular,  production  has 
been  only  a  fraction  of  what  is  possible.  A  hastily 
organized  and  in  many  respects  incomplete  government- 
operated  system  has  more  than  doubled  the  total 
production  in  this  country.  With  intelligent  co- 
operation between  the  great  producers,  a  vast  increase 
in  total  production  can  be  achieved,  even  with  our 
existing  knowledge  of  productive  methods. 

There  is  great  hope  for  a  better  economic  system 
in  this  new  knowledge.  All  that  is  wanted  to  make 
good  use  of  it  is  the  will  and  the  exercise  of  the  best 


THE    ECONOMIC   FUNCTIONS   OF   GOVERNMENT      423 

brains  of  the  country  on  the  problem  of  satisfying 
desires  instead  of  reaping  fortunes. 

Our  war  experience  sheds  a  great  light  on  some  of  the 
theories  which  have  been  advanced  from  time  to  time 
by  reformers  and  even  by  dreamers,  and  we  shall  turn, 
in  our  final  chapter,  to  a  consideration  of  some  of 
the  most  important  theories  of  social  and  economic 
reconstruction. 


CHAPTER  XXX 

PROPOSALS   FOR   SOCIAL  RECONSTRUCTION 

Economic  Organization  a  Steady  Growth  —  From 
time  to  time  in  the  preceding  chapters  we  have  tried 
to  show  that  our  social  and  economic  organization  is 
the  result  of  a  gradual  growth.  \Ve  do  not  progress  by 
leaps  and  bounds,  although  at  times  it  appears  that  a 
great  step  forward  has  been  taken.  Insensibly  changes 
are  taking  place  and  realization  of  the  changes  only 
develops  when  they  have  become  obvious  through  the 
difference  between  present  and  fairly  distant  times. 
No  sudden  great  change  has  much'  chance  of  being 
permanent.  The  instinct  of  conservatism  which  is 
strong  in  us  all  tends  to  prevent  the  success  of  any 
absolutely  radical  change.  Those  steps  in  progress 
which  have  appeared  to  be  of  great  importance  can 
usually  be  traced  by  the  historian  to  a  long  line  of 
small  developments  all  preparing  the  way  for  the 
change. 

Society  Dynamic,  not  Static  —  In  spite  of  this,  from 
time  immemorial  men  have  tried  to  imagine  or  con- 
struct new  schemes  of  society  which  would  be  an  im- 
provement on  the  existing  system.  From  Plato  to 
H.  G.  Wells  we  have  had  our  Utopians.  There  is, 
however,  a  noticeable  difference  between  the  Utopias 
constructed  in  the  past  and  those  which  are  suggested 
in  our  present  generation,  for  we  have  not  lost  the 


PROPOSALS   FOR  SOCIAL   RECONSTRUCTION    425 

desire  for  the  perfect  life.  The  older  schemes  of  state 
reconstruction  were  static.  That  is,  they  were  schemes 
for  a  perfect,  completed  organization  which  was  to  be 
the  last  word  in  organization.  Perfection,  however, 
is  the  very  negation  of  life.  When  a  thing  is  perfect 
there  is  nothing  further  to  strive  for.  In  our  very  best 
efforts  there  is  always  a  little  short  of  absolute  per- 
fection. We  see  this  in  every  phase  of  life  —  in  art, 
in  science,  in  literature,  in  music.  No  matter  how 
great  the  artist,  writer,  or  composer,  there  will  always 
be  the  critic  to  point  out  his  shortcomings.  Our 
modern  Utopians  realize  the  fact  that  the  perfect 
society  is  always  ahead  of  us  and  can  never  be  present ; 
they  know  that  a  society  which  has  no  goal  toward 
which  it  strives  is  dying.  Hence  we  have,  instead  of 
the  older  static  schemes  of  a  realized  perfection,  the 
dynamic  state  —  a  living  system  which  has  all  the 
elements  of  growth.  That  the  suggestions  are  attempts 
at  picturing  perfection  cannot  be  denied,  but  there  is 
always  the  realization  that  in  practice  difficulties  would 
arise  —  difficulties  to  be  overcome  by  careful  thought 
and  a  re-solving  of  problems. 

All  Utopias,  however,  have  as  their  basis  a  feeling 
that  the  existing  state  is  unsatisfactory.  Hence  the 
very  schemes  that  are  propounded  as  a  cure  for  these 
evils  constitute  in  the  first  place  a  criticism. 

Failure  of  Communistic  Experiments  —  The  inventor 
and  discoverer  is  always  impatient  at  the  slowness  of 
his  fellows;  so  impatient,  in  fact,  that  in  schemes  of 
social  reconstruction  in  particular,  he  is  anxious  to  try 
experiments.  It  may  be  said  at  the  outset  that  all 
the  schemes  that  have  been  tried  have  proved  to  be 


426  AN   INTRODUCTION   TO   ECONOMICS 

failures  ;  but  this  fact  does  not  detract  from  the  possi- 
bility of  the  ideas  being  of  great  value  in  a  growing 
social  organization.  Communism  has  been  attempted 
at  various  times  and  in  various  places,  occasionally 
with  temporary  success  and  ultimate  failure,  sometimes 
with  failure  from  the  start.  This  does  not,  however, 
prove  that  communism  is  an  absolute  failure  as  a 
solution  of  the  social  problem.  We  have  seen,  in  the 
course  of  our  study,  that  all  history  proves  the  growing 
interdependence  of  human  beings.  The  economic  unit 
has  steadily  grown  until,  as  far  as  civilized  countries 
are  concerned,  it  covers  the  whole  world.  No  group 
can  separate  itself  permanently  from  the  great  social 
organism  and  hope  to  have  a  real  effect  upon  that 
organism.  Even  if  successful  for  a  time,  its  very 
isolation  tends  to  bring  about  its  own  ultimate  de- 
struction. 

The  idea  that  man  would  be  better  off  if  he  shared 
everything  with  his  neighbors  finds  support  from  a 
great  number  of  people  who  are  dissatisfied  with  the 
existing  scheme  of  distribution.  Private  property  has 
been  declared  to  be  at  the  root  of  all  the  evils  of 
which  they  complain.  Hence  the  solution  of  the 
problem  lay,  to  their  minds,  in  the  abolition  of  private 
property.  The  supporters  of  communism,  however, 
are  comparatively  few  at  present,  and  the  greater 
part  of  the  schemers  for  a  better  system  pin  their 
faith  to  one  form  or  other  of  what  is  called  socialism. 

Socialism  —  It  has  been  frequently  necessary  to 
remark  that  words  are  used  colloquially  in  many 
different  senses,  and  for  the  purpose  of  scientific 
discussion  it  is  necessary  to  give  a  sharp  definition  to 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    427 

each  term  used.  Terms  which  are  common  in  political 
thought  are  probably  more  subject  to  varying  inter- 
pretations than  any  others.  Take  the  common  terms, 
Democrat  and  Republican,  in  our  American  politics! 
Is  it  possible  to  define  accurately  the  meaning  of  these 
terms,  apart  from  the  incomplete  definition  contained 
in  the  suggestion  that  they  refer  respectively  to 
members  of  the  Democratic  and  Republican  parties? 
Just  as  it  is  impossible  to  give  a  definition  of  these 
two  political  names,  so  also  is  it  impossible  to  define 
socialism  in  a  manner  which  will  satisfy  all  socialists. 
Moreover,  the  ideas  of  the  meaning  of  socialism 
held  by  those  who  do  not  claim  to  be  socialists  are  at 
infinite  variance  from  the  meaning  attached  to  the 
term  by  its  professors.  How,  then,  are  we  to  discuss 
socialism  with  any  degree  of  satisfaction  ? 

Though  the  variants  of  socialism  are  very  numerous, 
there  is  a  certain  idea  running  through  all  the  forms 
which  is  essentially  the  same  in  each.  We  shall, 
therefore,  before  discussing  one  or  two  of  the  prin- 
cipal forms,  consider  the  main  idea  which  pervades 
them  all. 

Socialist  Criticisms  —  Like  all  other  more  or  less 
Utopian  schemes,  socialism  commences  with  a  criticism 
of  the  existing  system.  The  nature  of  the  criticism 
necessarily  points  out  the  methods  by  which  the  evils 
are  sought  to  be  abolished.  Social  organization  has  its 
only  justification  in  the  satisfaction  of  the  needs  of 
the  individuals  who  compose  society.  Just  in  so  far 
as  the  organization  succeeds  in  meeting  the  require- 
ments of  its  members,  is  it  successful.  What  are  the 
essential  needs  of  the  members  of  society,  i.e.,  humanity 


428  AN   INTRODUCTION   TO   ECONOMICS 

at  large?  They  consist  of  three  groups.  In  the  first 
place  the  physical  needs  must  be  satisfied.  These 
are  the  provision  of  food,  clothing,  and  shelter.  Any 
organization  which  does  not  make  provision  for  these 
primary  needs  is  an  obvious  failure.  How,  then, 
does  our  present  system  succeed  in  this  respect  ?  All 
who  are  actually  alive  serve  to  prove  that  there  is  at 
least  a  measure  of  success.  The  socialist,  however, 
claims  that  the  measure  is  so  small  that  it  is  hardly 
worth  considering.  He  points  out  the  vast  inequalities 
in  distribution  of  food,  clothing,  and  shelter ;  the 
coarse,  impure,  and  insufficient  food  of  the  poor ;  the 
overabundant  and  ridiculously  elaborate  meals  of  the 
rich.  He  contrasts  the  rags  which  clothe  the  poorest, 
the  inartistically  designed  and  poorly  constructed 
clothes  of  the  lower  classes,  with  the  garments  of  the 
wealthy  classes,  especially  the  marvelous  creations 
which  adorn  the  wives  and  daughters  of  the  wealthy. 
The  hovels  in  which  many  thousands  of  the  poor  are 
housed  and  the  badly  designed  and  still  worse  con- 
structed dwellings  of  the  average  workman  and  even 
the  houses  of  the  middle  class  bear  no  comparison  with 
the  dwellings  of  the  millionaire. 

A  system  which  allows  of  such  inequalities  cannot 
be  said  in  any  way  to  be  successful.  The  criticism  does 
not  imply,  of  course,  that  there  should  not  exist  the 
expensive  and  highly  artistic  dwellings;  on  the  con- 
trary, the  socialist,  as  a  rule,  desires  that  the  number 
of  these  should  be  even  greater  than  at  present.  He 
does  say,  however,  that  where  these  wealthy  homes 
are  only  possible  because  of  the  existence  of  the  average 
outrage  on  architecture  and  workmanship  in  which 


PROPOSALS  FOR   SOCIAL   RECONSTRUCTION    429 

the  bulk  of  the  population  is  housed,  the  system  is  an 
ugly  failure. 

In  the  second  place,  society  must  provide  for  the 
conventional  necessaries.  Man  does  not  live  by  bread 
alone.  He  is  not  content,  and  he  should  not  be  con- 
tent, with  the  bare  means  of  subsistence  or  even  with 
abundance  of  coarse  but  satisfying  food,  warm  but 
uncomfortable  and  inartistic  clothing,  efficient  but 
inconvenient  and  ugly  shelter.  He  desires,  and  he 
ought  to  desire,  variety  of  food,  satisfactory  in  quantity 
and  as  nearly  perfect  in  quality  as  is  possible.  The 
same  is  true  of  his  clothing  and  his  housing. 

There  is  more  to  life,  however,  than  the  mere  physical 
fact  of  living.  The  progress  of  civilization  is  the  growth 
of  the  desires  of  man.  The  savage  is  content  almost 
with  the  bare  physical  necessaries,  but  the  higher 
in  the  scale  of  civilization,  the  greater  are  the  number 
and  variety  of  the  desires  of  the  individual.  Music 
and  leisure  to  enjoy  and  practice  it;  art  and  the 
knowledge  to  pursue  and  appreciate  it;  the  joy  of 
wresting  the  secrets  from  nature  and  advancing 
scientific  knowledge  —  all  these  and  more  form  part 
of  the  real  necessaries  of  life.  Luxury  exists  to-day 
and  is  often  senseless;  it  is  the  expression  rather  of 
the  power  of  spending  than  of  the  desire  to  enjoy  to  the 
full  the  blessings  of  life.  It  tends  not  to  the  increase 
of  man's  desires,  but  rather  to  the  decrease  of  the 
general  satisfactions  in  order  to  satisfy  the  more  or 
less  inane  wants  of  the  idle  rich. 

The  socialist  does  not  contend  that  all  luxury  should 
be  abolished.  But  he  does  insist  that  luxury,  especially 
the  type  which  is  common  to-day,  has  no  right  to 


430  AN   INTRODUCTION   TO   ECONOMICS 

existence  while  there  are  vast  masses  of  the  people 
who  are  reduced  almost  to  the  bare  level  of  subsistence. 
He  does  not  share  the  idea  that  the  refinements  of 
ease  and  of  leisure  are  of  themselves  immoral ;  rather 
the  opposite.  He  insists  on  the  right  of  all  to  gain  the 
greatest  amount  of  enjoyment  and  pleasure  out  of  life. 

In  these  two  aspects  of  the  socialist  criticism  of  life 
as  it  is  lived  at  present,  the  essential  point  of  the 
criticism  is  that  the  method  of  distributing  the  prod- 
ucts of  our  economic  energy  is  fundamentally  wrong. 
There  are  some,  of  course,  who  suggest  that  wealth 
as  it  is  produced  should  be  shared  by  all  equally,  but 
this  is  not  necessarily  a  fundamental  principle  of 
socialism.  Many  who  call  themselves  socialists  do 
not  desire  the  absolute  equality  of  income  for  all,  but 
recognize  the  value  of  a  certain  amount  of  diversity  of 
income.  None,  however,  will  admit  that  the  great  in- 
equalities which  exist  to-day  are  necessary,  still  less 
advisable. 

The  severest  criticisms,  however,  lie  in  the  realm  of 
production  rather  than  in  distribution.  It  might  con- 
ceivably be  possible  to  arrange  a  new  method  of  dis- 
tribution without  absolutely  reorganizing  the  basis  of 
modern  economic  life.  But  the  socialists  declare  that 
the  method  of  production  —  the  competitive  method  — 
which  rules  our  economic  system,  is  fundamentally 
unsound.  Its  basis  is  the  belief  that  scientific  selfish- 
ness produces  the  best  and  most  abundant  production. 
We  have  seen  in  our  account  of  the  competitive  system, 
that  the  real  aim  of  the  producing  individuals  was  not 
the  rendering  of  service  to  the  community  and  exacting 
a  reward  for  such  service.  The  aim  was  to  secure  the 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    431 

reward  —  the  service  was  incidental.  The  farmer 
cultivates  the  ground  for  the  sake  of  the  price  he 
receives  for  his  product,  not  for  the  sake  of  providing 
food  for  the  people.  The  shipbuilder  builds  his  vessels 
in  order  that  he  may  gain  as  large  a  sum  as  possible 
from  the  man  who  is  to  use  the  ships,  not  in  order  to 
facilitate  the  interchange  of  commodities  and  so  increase 
the  welfare  of  the  nations.  Incidentally  the  people  are 
fed  and  the  goods  are  interchanged.  But  these  services 
are  performed  in  a  very  inefficient  manner.  Effort 
is  not  economized,  but  rather  wasted,  and  wasted  on  a 
colossal  scale.  Instances  abound.  Take  the  case  of 
the  retailing  of  groceries,  for  example.  In  any  city  we 
can  see  the  great  multiplication  of  little  stores,  each 
with  its  variety  of  goods  for  sale.  In  none  is  there  a 
complete  stock,  and  customers  go  from  one  store  to 
another,  buying  a  little  here  and  a  little  there.  In- 
efficient buying  on  the  part  of  the  dealer  results  in  goods 
lying  on  the  shelf  in  one  store  while  there  is  a  shortage 
in  others.  In  the  case  of  perishable  goods,  the  waste 
is  still  worse.  Goods  are  actually  left  to  spoil  because 
they  happen  to  have  been  bought  too  freely  by  one 
storekeeper,  and  his  customers  do  not  absorb  them. 
The  bigger  stores  have  realized  this  waste  and  have  to 
a  large  extent  eliminated  it  in  their  own  organizations. 
Even  in  the  case  of  the  large  chain  stores,  however,  there 
is  waste  due  to  competition  with  independent  stores. 

Take  production  on  a  larger  scale,  like  the  manu- 
facture of  steel  goods.  At  times  we  have  the  bulk  of 
the  factories  working  at  full  speed,  but  it  is  commoner 
for  each  to  be  working  at  less  than  full  speed  —  some 
of  the  machinery  idle  all  the  time.  This,  declares  the 


432  AN   INTRODUCTION   TO   ECONOMICS 

socialist,  means  the  waste  of  effort  caused  by  producing 
more  machinery  than  is  necessary.  Again  little  manu- 
facturers still  exist  competing  for  the  odds  and  ends  of 
trade  with  inefficient  and  more  or  less  obsolete  equip- 
ment, taking  toll  of  the  muscles  and  minds  of  those 
who  work  it,  when  the  muscular  and  mental  effort 
might  be  saved  by  using  the  more  modern  tools  and 
machines. 

The  competitive  method,  moreover,  introduces  one 
type  of  worker  whose  energies  are  almost  entirely 
waste.  The  advertiser  is  absolutely  necessary  to 
business  as  it  is  conducted  to-day.  Look  at  our  adver- 
tisements of  motors.  Each  manufacturer  is  striving 
to  tell  how  good  his  own  machine  is  in  as  seductive  a 
manner  as  possible.  It  cannot  be  true  that  all  are 
equally  good,  but  it  is  perfectly  possible  that  there  is 
little  to  choose  between  a  score  or  so  of  the  best.  At 
a  given  price  there  is  probably  little  real  variation  in 
quality.  Yet  the  cost  of  the  advertisements  accounts 
for  a  very  considerable  proportion  of  the  selling  price. 
It  accounts,  also,  for  a  very  great  amount  of  what,  to 
the  socialist,  is  waste  of  individual  effort  on  the  part 
of  advertisement  writers,  artists,  draftsmen,  printers, 
and  so  forth. 

The  keynote  of  the  socialist  criticism  of  the  existing 
system  of  economic  production  is  to  be  found  in  the 
word  waste  —  waste  of  effort,  of  time,  and  of  material. 

With  a  great  deal  of  this  criticism  we  must  needs 
agree.  No  sane  man  will  refuse  to  admit  that  dis- 
tribution of  wealth  is  absurdly  inequitable  at  present. 
Even  the  wealthiest  admit  it  and  often  try  to  minimize 
the  evils  of  the  distribution  by  a  voluntary  offering  of 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    433 

part  of  their  wealth  to  those  less  fortunate.  It  will 
also  be  readily  granted  that  the  workman  (using  the 
term  in  its  broadest  sense)  is  entitled  to  a  greater  return 
for  his  efforts  than  he  actually  obtains. 

It  is  not  so  freely  granted,  however,  that  the  leisure 
of  the  hardest  workers  at  present  should  be  increased. 
We  have  still  too  much  of  the  Puritan  feeling  that  pleas- 
ure is  evil  and  that  idleness  is  productive  of  all  sorts 
of  mischief.  Yet  a  little  thought  will  be  sufficient 
to  show  that  work,  except  in  comparatively  small 
quantities,  is  not  of  itself  a  blessing.  It  is  a  means  to 
an  end  and  there  is  far  too  great  a  tendency  to  regard 
the  means  as  the  end  itself.  No  man  can  be  a  good 
citizen  whose  mind,  at  its  freshest,  is  used  on  his  work 
alone,  and  who  gives  the  more  or  less  exhausted  brain 
power  to  the  real  business  of  being  happy  and  assisting 
others  to  be  so.  We  smile  at  the  eccentricities  of  the 
artist  and  the  inventor,  but  there  is  just  a  little  envy 
in  our  smile. 

A  socialist  street  orator  put  the  whole  situation 
very  aptly,  if  his  language  does  seem  confused,  when 
he  said  that  "  what  we  want  is  more  work  and  less  of  it." 
What  he  meant  was,  that  we  should  work  rationally, 
not  wearing  ourselves  out  with  toil  for  a  few  weeks  or 
months,  and  then  lying  idle  for  a  similar  or  longer 
period.  Our  periods  of  working  should  be  of  shorter 
duration,  but  they  should  be  steadier.  From  the  point 
of  view  of  economic  working,  there  cannot  be  any  denial 
of  this  belief.  Experience  has  proved  time  and  time 
again,  that  long  periods  of  work  produce  poor  workman- 
ship. It  is  not  a  mere  chance  that  the  bulk  of  the 
accidents  which  occur  in  industry  take  place  toward 


434  AN   INTRODUCTION   TO   ECONOMICS 

the  end  of  the  working  day.  Long  periods  of  un- 
employment, also,  tend  to  produce  the  unemployable. 
We  are  very  largely  creatures  of  habit,  and  when  we 
get  in  the  habit  of  doing  a  certain  amount  of  work 
each  day,  we  do  not  feel  the  same  desire  for  idleness 
as  when  we  alternate  periods  of  great  effort  with  periods 
of  complete  idleness.  To  put  the  matter  briefly, 
experience  proves  that  the  average  human  being  re- 
quires both  work  and  idleness,  and  it  is  false  economy 
to  allot  the  idleness  to  one  group  of  individuals  and  the 
work  to  another.  That  sort  of  "  division  of  labor  " 
is  one  of  the  few  varieties  which  do  not  conduce  to 
economic  efficiency. 

Turn  now  to  the  question  of  waste  in  the  competitive 
organization.  The  whole  trend  of  development,  as 
we  have  attempted  to  show  in  the  preceding  chapters, 
is  towards  the  elimination  of  the  very  competition 
which  is  still  sometimes  spoken  of  as  the  "  life  of 
trade."  The  strongest  arguments  in  favor  of  big 
business  and  unified  control  are  those  based  on  the 
economies  resultant  from  the  removal  of  competition. 
Perhaps  the  average  individual,  especially  in  America, 
will  not  admit  the  importance  which  the  socialist 
places  upon  this  economic  waste.  In  the  case  of 
advertising,  for  instance,  there  are  advertising  asso- 
ciations all  over  the  country  whose  members  will 
always  be  ready  to  justify  their  occupation  upon 
sound  economic  grounds,  and  it  is  worth  while  for  a 
moment  to  consider  some  of  these  grounds.  It  is 
asserted  that  nothing  can  be  sold  to  people  unless  they 
know  about  it.  Indeed,  some  people  cannot  be  made 
to  appreciate  a  good  article  unless  its  goodness  is 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    435 

drilled  into  them  by  constant  repetition.  Does  the 
advertiser,  however,  really  base  the  justification  of  his 
business  upon  this  belief?  Admitting  its  truth,  as 
we  are  forced  to  do,  does  this  justify  the  advertising 
that  occupies  so  large  a  space  in  our  magazines  and 
newspapers?  Most  advertising  experts  will  agree 
that,  while  advertising  will  help  to  sell  for  a  certain 
time  a  commodity  which  does  not  nearly  live  up  to  the 
advertised  recommendations,  unless  the  commodity 
has  a  real  value  or  rather  unless  it  satisfies  a  real 
desire,  advertising  will  not  secure  permanent  sales. 
Still,  there  are  few  commodities  which  are  as  good  as 
the  advertisements  declare,  and  a  well-advertised  article 
will  sell  more  rapidly  than  a  better  one  which  is  not  so 
widely  known.  There  is  a  strong  tendency  nowadays 
for  advertisements  to  be  more  accurate  in  their  de- 
scriptions of  the  advertised  goods  than  was  formerly 
the  case,  but  the  best  that  can  be  said  is  that  a  cer- 
tain amount  of  advertisement  is  an  absolute  necessity. 
The  degree  to  which  this  method  of  attracting  attention 
to  goods  is  carried  at  the  present  day  is,  however,  far 
greater  than  can  possibly  be  justified.  If  we  cannot 
admit  the  full  strength  of  the  socialist's  argument,  at 
least  we  must  admit  that  there  is  a  great  deal  to  be  said 
for  the  criticism  he  urges. 

In  the  main,  therefore,  we  may  say  that  the  criticisms 
against  our  present  economic  system,  which  are  urged 
by  socialists  and  by  others  who  would  indignantly 
repudiate  the  title,  are  sound.  The  disagreement 
comes  with  the  suggestions  for  the  removal  of  the  evils. 
We  must  now  turn  our  attention  to  these  suggestions 
and  endeavor  to  see  what  value,  if  any,  there  lies  in  the 


436  AN   INTRODUCTION   TO   ECONOMICS 

various  socialist  and  other  programs  of  social  recon- 
struction. 

The  Central  Idea  of  Socialism  —  The  socialist  pro- 
grams, multitudinous  as  they  are,  have  as  a  rule  one 
idea  in  common ;  that  idea  is  that  society  should  not 
be  based  upon  private  enterprise,  with  the  stimulus  of 
private  profit.  The  socialist  rejects  entirely  the  idea 
of  competition,  and  substitutes  therefor  the  idea  of 
co-operation.  He  removes  the  aim  of  profit  and  in 
place  of  it  substitutes  the  aim  of  service.  Where,  under 
the  present  economic  system,  private  individuals  own 
the  means  of  production,  including  the  land,  and  where 
the  landless  and  propertyless  part  of  the  population 
bargains  for  the  sale  of  its  labor,  the  socialist  would 
have  the  means  of  production  owned  in  common,  and 
of  distribution  on  the  basis  of  the  needs  of  the  in- 
dividual. The  socialist  ideal  is  that  each  should 
receive  according  to  his  needs  and  give  (in  service) 
according  to  his  capacity. 

Revolutionary  Socialism  —  As  we  have  said,  there 
are  many  forms  of  socialism,  but  we  shall  distinguish 
three  main  divisions.  There  are  those  who  believe 
that  the  competitive  system  will  fall  of  its  own  weight. 
They  think  that  the  whole  tendency  of  modern  economic 
development  is  toward  the  elimination  of  competition 
and  the  evolution  of  big  businesses,  resulting  in  a  con- 
centration of  wealth  in  the  hands  of  a  very  few  people. 
This  concentration  will,  of  itself,  produce  a  revolution 
against  the  possession  of  enormous  wealth  in  the 
hands  of  a  very  small  proportion  of  the  population, 
and  the  state  will  take  over  the  responsibilities  of 
production  from  the  hands  of  those  who  have  con- 


PROPOSALS   FOR  SOCIAL   RECONSTRUCTION     437 

trolled  it.  Those  who  hold  this  view  are  prepared 
to  let  the  elimination  of  competition  proceed  of  its 
own  accord  until  the  time  is  ripe  for  the  national 
organization  to  assume  control,  and  they  believe  that 
this  ultimate  assumption,  regarded  as  an  inevitable 
fact,  will  require  a  revolution. 

There  is  much  that  is  true  in  the  first  contention  of 
the  revolutionary  socialists.  There  is  an  undoubted 
tendency  to  eliminate  competition  —  we  have  already 
noticed  this  fact.  But  because  a  tendency  exists,  it 
does  not  necessarily  follow  that  it  will  be  carried  out 
to  its  logical  conclusion.  Even  in  the  organization 
of  big  businesses  we  have  already  noticed  the  fact  that 
if  the  business  is  organized  on  too  large  a  scale  the  law 
of  decreasing  returns  comes  into  force.  There  is  a 
limit  to  the  size  of  each  industry,  as  far  as  the  individual 
plant  is  concerned.  The  same  is  also  true  so  far  as  the 
industry  as  a  whole  is  concerned,  especially  when 
geographical  conditions  are  taken  into  consideration. 
It  would  be  absurd,  for  example,  to  have  the  street 
railways  of  the  different  cities  of  this  country  run  by  a 
single  national  organization,  whether  that  organization 
be  privately  or  publicly  owned. 

Neither  does  it  follow  that,  even  if  the  tendency  to 
the  elimination  of  competition  is  carried  to  its  logi- 
cal conclusion,  the  government  will  be  forced  by 
a  revolution  to  assume  operation.  Many  possibilities 
may  occur  in  the  meantime  to  give  increased  control, 
without  actual  ownership  by  the  government.  Revo- 
lutions, moreover,  are  always  dangerous.  This  does 
not  mean  that  they  are  never  necessary.  The  history 
of  the  United  States  shows  that  sometimes  the  only 


438  AX    INTRODUCTION   TO   ECONOMICS 

solution  of  a  political  difficulty  is  a  revolution.  But 
a  sudden  change  of  the  form  of  government  or  of  the 
economic  system  is,  as  a  rule,  not  a  thing  to  be  desired. 
Until  recent  years,  the  tendency  of  socialist  thought 
was  against  revolution  and  was  directed  towards 
evolution. 

State  Socialism  —  The  evolutionary  socialists,  or  as 
they  are  better  called,  the  State  Socialists,  believed 
in  the  gradual  assumption  by  government  of  all  the 
means  of  production.  They  would  begin  by  securing 
government  ownership  of  the  principal  natural  monop- 
olies, like  the  means  of  transport,  the  provision  of 
light  and  power,  and  so  forth,  and  then  gradually 
extend  the  scope  of  government  economic  effort  until 
all  industry  was  carried  on  under  government  owner- 
ship. It  was  taken  for  granted  that  the  land  would  be 
nationalized  and  then  the  mines. 

In  support  of  the  contention  that  the  government 
could  operate  successfully  the  great  business  organi- 
zations the  socialists  pointed  out  the  fact  that  already 
the  government  carried  on  great  industries.  The 
carriage  of  the  mails  alone  represents  a  great  business 
organization.  Governments  in  different  countries  have 
owned  and  operated  railroads.  In  time  of  war,  the 
government  has  been  compelled  to  assume  control  of 
privately  owned  industries  and,  in  spite  of  the  difficulties 
incidental  to  hurried  reorganization,  these  industries 
have,  on  the  whole,  been  efficiently  managed. 

In  the  smaller  organizations  of  government  like 
the  municipalities,  much  greater  strides  have  been 
made  in  government  ownership  and  operation  of 
industry.  Municipal  street  railways,  gas  and  electric 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    439 

systems,  water  systems,  and  so  forth,  are  common, 
and  they  are  as  a  rule,  fairly  well  managed ;  so  well! 
in  fact,  that  there  are  very  few  cases  where  the  muni- 
cipalities would  care  to  go  back  to  the  system  of  private 
ownership.  Municipal  markets,  dairies,  theaters  are 
becoming  commoner  every  day.  To  all  these  instances 
of  socially  owned  and  operated  business,  the  socialist 
points,  and  draws  the  moral  that  what  can  be  done  in 
one  place  and  with  one  industry  can  be  done  in  another 
and  with  other  industries.  All  that  the  state  socialist 
asks  is  that  the  governments,  including  the  local 
governments  as  well  as  the  national,  should  gradually 
increase  their  economic  functions  until  private  enter- 
prise in  business  and  private  ownership  of  the  means  of 
production,  should  cease. 

Now  this  proposition  assumes,  among  other  things, 
that  governments  are  both  honest  and  efficient.  If 
they  are  neither,  there  is  very  little  chance  of  success. 
If  we  could  be  reasonably  sure  that  government  officials 
would  only  be  appointed  on  the  basis  of  efficiency  for 
their  job,  and  that  their  administration  should  be 
honest,  there  is  no  reason  to  suppose  that  government 
ownership  and  operation  of  industry  would  not  be 
considerably  more  successful  than  the  present  method. 
Honesty  and  efficiency  on  the  part  of  government, 
however,  is  determined  by  the  interest  displayed  in 
government  by  the  people  as  a  whole.  Government 
officials  can  be  dishonest  and  attend  to  their  own 
interests,  when  they  know  that  the  supervision  of 
their  work  is  inefficient.  When  the  public  only  cares 
for  the  excitement  of  politics,  and  cares  for  that  only 
spasmodically,  as  seems  to  be  the  case  at  present,  there 


440  AN   INTRODUCTION   TO   ECONOMICS 

is  little  chance  that  governments  will  be  really  efficient. 
We  are  apt,  however,  to  underrate  rather  than  to 
overrate  government  efficiency ;  and  at  the  same  time 
we  are  just  as  apt  to  err  in  the  other  direction  when 
dealing  with  private  enterprise.  We  assume  efficiency 
in  private  enterprise,  and  we  assume  inefficiency  in 
public  enterprise.  Neither  assumption  is  warranted  by 
the  facts.  There  is  an  immense  amount  of  inefficient 
business  conducted  under  private  enterprise,  just  as 
there  is  also  a  great  deal  of  dishonesty.  On  the  other 
hand  there  is  much  careful,  painstaking,  and  really 
sound  work  done  under  national  and  municipal  govern- 
ments. 

The  great  danger  to  be  apprehended  kfrom  govern- 
ment operation,  as  it  has  been  suggested  by  the  state 
socialists,  is  what  is  colloquially  known  as  "  red  tape.'* 
A  great  many  socialists,  having  seen  the  actual  opera- 
tion of  government  control  of  industry,  in  England 
in  particular,  have  reluctantly  given  up  their  ideas. 
This  is  particularly  true  of  the  labor  parties  and  trade 
unionists.  Before  discussing  the  third  form  of  social- 
ism, we  may  spend  a  moment  in  considering  some 
objections  to  socialism  in  general. 

Objections  to  Socialism  —  Assuming  that  a  socialist 
state  were  organized,  every  one,  it  is  argued,  would  be 
on  a  dead  level ;  there  would  be  no  stimulus  to  increased 
effort,  and  therefore  there  would  be  little  chance  of 
real  progress.  Government  would  tend  rapidly  to 
laying  down  the  law  as  to  what  is  to  be  produced, 
and  those  individuals,  who  were  comparatively  few  in 
number,  would  be  unable  to  satisfy  unusual  require- 
ments. Inventors  would  have  little  chance  of  obtaining 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    441 

consideration  for  their  inventions,  as  the  government 
would  always  be  inclined,  through  its  officials,  to  be 
too  conservative.  Hence  business  and  economic  effort 
generally  would  be  inclined  to  stagnate. 

It  is  generally  felt  by  opponents  of  socialism  that 
personal  initiative,  which  means  so  much  in  progressive 
civilization,  would  be  lost.  There  would  be  no  in- 
centive to  effort,  is  the  argument,  and  therefore  there 
would  be  no  effort  except  the  perfunctory  effort  of 
the  traditional  government  employee.  To  these  argu- 
ments, the  socialist  replies,  first,  that  there  is  nothing 
to  support  the  idea  that  there  would  be  no  personal 
initiative  under  government  employ  beyond  the  state- 
ment of  the  opponents  of  socialism,  and  second,  that 
when  these  opponents  say  that  there  would  be  no  in- 
centive to  work,  what  they  mean  is  that  there  would  be 
no  financial  incentive.  We  have  already  discussed  the 
question  of  incentives  to  work  in  a  previous  chapter  and 
noted  that  there  are  many  besides  the  merely  pecuniary 
stimuli.  Finally  it  is  said  that  the  traditional  govern- 
ment employee  is  merely  traditional  —  he  does  not 
exist  in  fact  to  anything  like  the  extent  that  is  generally 
supposed. 

In  any  case  the  newer  socialism  provides  for  a  system 
of  control  of  industry  which  will  secure  capable  organ- 
ization and  efficient  work. 

Guild  Socialism  —  The  modern  idea  of  what  has 
been  called  in  England,  Guild  Socialism,  has  much  in 
common  with  a  developed  French  idea  of  syndicalism. 
Perhaps  it  will  be  better  to  start  with  the  French  idea 
first  before  we  attempt  to  discuss  its  English  and 
American  equivalents.  French  political  philosophers 


442  AN   INTRODUCTION   TO   ECONOMICS 

have  been  pointing  out  for  the  past  dozen  years  or  so, 
that  the  rough  division  of  economic  society  into  em- 
ployer and  employed  is  unsatisfactory  for  many  reasons. 
We  are  all  associated  with  one  another,  but  there 
are  groups  which  are  closely  associated.  In  fact  the 
greater  the  advance  of  civilization,  the  greater  is  the 
number  of  groups  with  which  one  individual  becomes 
connected.  A  man  is  closely  related  with  his  fellow 
workers  in  the  trade  by  which  he  earns  his  living.  He 
is  associated  with  his  fellow  church  members,  club 
members,  benefit  society  members,  athletic  association 
members,  and  so  on.  It  is,  however,  with  the  members 
of  his  particular  industry  that  he  is  most  closely 
related.  This  means  that  the  association  is  not  partic- 
ularly with  the  craft  which  he  exercises.  A  man  may 
be  a  carpenter  and  be  more  closely  related  to  the  brick- 
layers who  are  employed  in  the  same  business  unit  than 
with  carpenters  belonging  to  a  different  unit.  The 
unit  is  rather  the  industry  than  the  trade.  It  is 
becoming  more  and  more  recognized  that  the  actual 
workers  in  an  industry  must  have  a  greater  say  in  the 
conduct  of  that  industry  than  has  hitherto  been  the 
case. 

A  satisfactory  trade  organization  will  include  among 
its  management  not  only  the  organizers  but  also 
those  who  are  engaged  in  carrying  out  the  organization, 
or  their  representatives.  Some  of  the  foremost  of  the 
French  political  thinkers  believe  that  society  is  tending 
to  become  more  and  more  organized  into  trade  groups, 
each  group  organizing  and  controlling  its  own  trade  — 
the  railway  men  controlling  the  railways,  the  spinners, 
weavers,  and  dyers  controlling  the  textile  trades,  and 


PROPOSALS   FOR   SOCIAL   RECONSTRUCTION    443 

so  forth.  Already  we  find  the  professional  classes 
organized  in  this  manner ;  the  lawyers  actually  control 
the  legal  profession;  the  doctors  lay  down  the  rules 
under  which  the  medical  profession  is  conducted. 
Now  there  is  only  a  difference  in  degree  between  control 
and  actual  ownership.  If  all  those  engaged  in  the 
building  trades,  that  is,  the  bricklayers,  carpenters, 
plumbers,  with  their  executive  heads,  actually  control 
the  industry  so  that  they  can  lay  down  the  prices  to  be 
charged  for  their  product,  and  the  wages  to  be  paid 
to  the  members,  this  amounts  to  practical  ownership 
of  the  industry. 

The  guild  socialists  of  England  have  had  experience 
of  government  control  and  do  not  wish  to  add  to  that 
experience.  They  demand  the  nationalization  of  the 
principal  industries  of  the  country,  but  they  object 
to  government  management.  They  ask  that  the 
industry  be  controlled  by  those  employed  in  the 
industry  —  the  railway  workers  (using  the  term  workers 
in  its  broad  sense)  controlling  the  railways,  and  mine 
workers  the  mines,  the  transport  workers  managing 
the  transport  industries  in  each  of  the  main  groups  of 
those  industries. 

In  America  we  see  the  development  of  this  idea  in 
the  suggestion  of  the  railway  brotherhoods  in  regard  to 
the  future  control  of  the  American  railways.  They 
desire  a  strong  representation  on  the  management 
board  for  the  railway  unions,  the  whole  system  being 
worked  so  that  a  good  living  wage  can  be  paid  to  all 
employees  and  the  profits  of  the  system  used  to  reduce 
rates  to  shippers. 

It  is  outside  our  province  at  present  either  to  praise 


444  AN   INTRODUCTION   TO   ECONOMICS 

or  criticize  these  schemes.  It  might  be  suggested, 
however,  that  too  much  stress  is  laid  by  guild  socialists 
on  the  importance  of  the  producers  in  connection  with 
the  industries  of  a  country.  After  all,  the  industry  does 
not  exist  for  the  sake  of  the  workers,  but  for  the  sake 
of  the  consumers,  and  it  would  hardly  seem  right  to 
place  the  consumers  at  the  entire  mercy  of  the  pro- 
ducers. Even  the  suggestion,  true  as  it  is,  that  the 
producers  themselves  are  the  consumers,  does  not 
affect  the  argument.  If  there  is  to  be  such  an  arrange- 
ment as  will  remove  the  profit  stimulus,  there  should 
be  representatives  on  the  management  who  will  see 
that  the  interests  of  the  consumers  are  cared  for. 

Conclusion  —  In  an  introductory  book  it  is  quite  im- 
possible to  give  adequate  consideration  to  the  infinite 
variety  of  suggestions  for  the  improvement  of  economic 
society.  We  have  attempted  to  describe  society  as  it  is, 
and  to  point  out  the  laws  under  which  it  works.  We 
have  admitted  that  the  results  are  far  from  being  all  that 
could  be  desired,  and  the  realization  of  this  fact  should 
in  itself  be  a  stimulus  to  the  search  for  a  better  organ- 
ization. There  only  remains  to  be  said  the  fact  that, 
whatever  be  our  present  suggestions  for  improvement, 
they  are  bound  to  change  as  conditions  change  and  as 
experience  shows  them  to  be  unsatisfactory.  It  is 
just  as  bad,  however,  to  denounce  all  new  schemes 
as  to  accept  blindly  one  panacea  or  another.  Names, 
whether  they  be  the  names  of  socialism,  anarch- 
ism, bolshevism,  or  individualism  mean,  in  them- 
selves, simply  nothing.  No  one  is  prepared  with 
a  satisfactory  definition  which  really  covers  the  whole 
content  of  the  terms.  What  we  must  seek  is  the 


PROPOSALS   FOR  SOCIAL   RECONSTRUCTION    445 

reality  behind  the  label,  using  careful  scientific  judg- 
ment and  not  blind  passion. 

Tub  thumping  at  street  corners  will  lead  us  no 
further  than  ignorant  rhetoric  in  newspapers.  In 
order  to  amend  our  society  we  must  first  understand 
it.  Our  study  of  economics  should  serve  as  a  basis 
upon  which  to  build  a  real  knowledge  of  the  economic 
structure  of  the  present  civilization.  It  rests  with  the 
student  to  fill  in  the  many  and  deep  gaps  which  have 
been  left  and  to  apply  his  knowledge  to  the  task  of 
so  reconstructing  society  that  the  evils  of  which  we 
are  conscious  shall  be  things  of  the  past. 


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OGG,  F.  A.     The  Economic  Development  of  Modern  Europe. 
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3.  MONEY  AND  BANKING 

JEVONS,   W.   S.     Money  and  the  Mechanism  of  Exchange. 
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WITHERS,  HARTLEY.     The  Meaning  of  Money.     New  York, 
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HOLDSWORTH,  J.  T.     Money  and  Banking.     New  York,  1917. 

WILLIS,  H.  PARKER.     American  Banking.     Chicago,  1916. 
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CONWAY  AND  PATTERSON.     The  New  Bank  Act.     Philadel- 
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BASTABLE,  C.  F.     The  Theory  of  International  Trade.     New 

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VEBLEN,  THORSTEIN  B.     The  Theory  of  Business  Enterprise. 
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DIEMER,  HUGO.     Industrial  Organization  and  Management. 

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CLARK,  J.  B.     The  Problem  of  Monopoly.     New  York,  1904. 

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ADAMS,  T.    S.,  AND    SUMNER,  H.     Labor  Problems.     New 

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HOBSON,  J.  A.     Work  and  Wealth.     New  York,  1914. 
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INDEX 


Acceptance,  280 

Collective  bargaining,  379 

Accommodation  loan,  202 

Commercial  bills,  283 

Advertising,  434 

Commercial  loans,  203 

Agents  of  production,  55,  et  seq. 

Communal  tillage,  92 

Agricultural  stage,  18 

Communism,  425 

Agriculture,  51 

Competition,  106 

American,  94 

idea  of,  32 

primitive,  91 

latent,  157 

American  Federation  of  Labor,  376 

meaning  of,  33 

Arbitrage,  286 

Competitive  system,  34-38 

Arbitration,  386 

Conciliation,  386 

Conditions  of  labor,  381 

Balance  of  trade,  265,  301 

Consular  invoice,  278 

Bank,  191,  et  seq. 

Consumer's  surplus,  139 

debtor  and  creditor,  200 

Consumption,  44-46 

loans,  201 

Co-operation,  395 

notes,  193 

Co-operative  production,  398 

Barter,  161 

Copyrights,  151 

Bills  of  lading,  279 

Corporations,  85,  88,  106 

Bimetallism,  178 

Craft  union,  374 

Bonds,  86,  87 

Creative  instinct,  352 

Bonus  systems,  367 

Credit  instruments,  191 

Boycott,  387 

Crises  and  panics,  229 

Business,  77 

Currency,  elastic,  186 

future  element  in,  310 

fluctuations  in  demand  for,  185 

inflation  of,  187 

Call  loan  system,  217 

payments,  270 

Canadian  banking  system,  243 

United  States,  180 

Capital,  51,  61,  95,  98 

Custom,  40 

flow  of,  147,  306 

loans,  202 

Deductive  method,  8 

Cattle  as  money,  162 

Demand,  curve  of,  137 

Chartered  companies,  81 

elasticity  of,  129,  158 

Check  payments,  269 

latent,  130 

Clearing  house,  197 

law  of,  133,  et  seq. 

Coinage,  171,  172 

Department  stores,  89 

debasement  of,  172 

Dependent  period,  16 

depreciated,  173 

Deposit  reserves,  195 

subsidiary,  177 

system,  192,  194 

451 


452 


INDEX 


Development,  20-21 
Diminishing  utility,  122 
Discount,  203-204 

rate,  221,  230 
Distribution,  320 
Division  of  labor,  19,  61-63 
Documented  draft,  280 
Domestic  exchange,  269,  et  seq. 
Dominating  instinct,  353 
Dose  of  capital  and  labor,  69 
Draft  payments,  271 
Dumping,  303 

Duties,  protective  and  revenue,  288 
Dynamic  civilization,  22 

Economic  freedom,  27,  37 
Economic  functions  of  government, 

407,  et  seq. 
Economic  history,  15 
Economic  laws,  0-7 
Economic  problem  stated,  25 
Economic  unit,  19 
Economics,  defined,  2,  et  seq. 
Effective  demand,  126 
Efficiency,  339 
Elasticity  of  currency,  235 
Elasticity  of  demand,  129 
Equality  of  sacrifice,  402 
Equation  of  indebtedness,  265 
Excess  profits,  tax,  405 
Exchange,  factors  of,  133-136 

mechanism  of,  249 

rate  of,  284 

Factory  organization,  103 

system,  98 

Federal  Reserve  Act,  224,  et  seq. 
Federal  Reserve  bank  notes,  237 
Federal  Reserve  notes,  231 
Fiat  money,  187 
Finance  bills,  284 
Foreign  exchange,  273,  et  seq. 
Foreign  payments,  method  of,  276 

Gild  socialism,  441 
Gild  system,  27,  96 


Gold,  181,  182 

movements,  266 

causes  of,  286 

payments,  270 

points,  275 

shipments,  cost  of,  274 
Government  ownership,  412,  et  seq., 

438 
Gresham's  Law,  175 

Holding  company,  113-116 
Hours  of  labor,  '382 

Idleness,  351 
Index  numbers,  188 
Inductive  method,  10 
Industry,  77 

government    regulation  of,  27-28, 
37,409 

location  of,  61 
Industrial  stage,  13 
Industrial  Union,  373 
Interest,  326 

rate,  285 
International,  definition  of,  254 

price,  263 

trade,  256-258 

value,  260 
Inventions,  22 
Investment,  307 
Iron  law,  359 
I.  W.  W.,  378 

Joint-stock  companies,  84 
Kartels,  109 

Labor,  56 

as  a  commodity,  34,  357 

definition  of,  355 

division  of,  19,  61-63 

market,  357 

organizations,  370,  374 
Land,  55 

Law  of  comparative  cost,  256 
Law  of  demand,  136 


INDEX 


453 


Law  of  diminishing  returns,  73 

Law  of  increasing  returns,  71-72 

Law  of  supply,  137 

Leisure,  434 

Letter  of  credit,  278 

Lockout,  385 

Low  wages,  a  cause  of  poverty,  345 

Luxuries,  42 

Manufacture,  96 
Margin  of  cultivation,  324 
Marginal  utility,  123 
Market,  definition  of,  143 

price,  141 
Mercantilism,  301 
Metallic  money,  169-170 
Mint  par,  273 
Money,  162,  et  seq. 

and  price,  181   • 

as  a  measure  of  value,  167 
Monopoly,    80,    111,    116-118,    146, 

151-156,  340,  410 
Monopoly  price,  157-159 

Nation,  definition  of,  254 
National  banking  act,  207,  et  seq. 
National  bank  notes,  210-213 
National  system,  298 
Necessities,     physical    and     conven- 
tional, 23,  24,  40 
Normal  price,  144 

Opportunity,  338 
Organizing  instinct,  353 

Panics,  229 
Partnerships,  79,  82 
Pastoral  period,  17 
Patents,  151 
Payment  by  tale,  174 
Perverse  elasticity,  212 
Piece  wages,  365 
Pools,  110 

Poverty,  causes  of,  341 
Price  agreements,  107 
Price,  definition  of,  127 


Price,  equation  of,  184-185 

fluctuations,  144 

international,  263 

market,  141 

measurement  of,  188 

monopoly,  157-159 

normal,  145 

par  and  investment,  CC9 

stability,  149,  317 
Producer's  surplus,  140 
Production,  28,  49  et  seq.,  66,  101, 

156 

Profits,  66,  329 
Profit  sharing,  369,  391 
Progress,  definition  of,  24 
Progressive  taxation,  405 
Proportional  taxation,  405 
Protection  of  young  industries,  292 
Protection  and  cheap  labor,  302 
Protective  taxation,  287 
Psychology,  3 

Quasi-rent,  326 

Rack-renting,  29 
Real  wages,  362 
Rediscount,  223 

market,  228 

Regulated  companies,  80 
Rent,  322,  325 
Reserves,  control  of,  220 

cost  of,  240 

under  National  banking  act,  213- 

219 

Revenue  taxation,  287 
Revolutionary  Socialism,  436 
Right  to  organize,  372 
Right  to  work,  351 
Rochdale  pioneers,  395 

Satisfaction,  present  and  future,  124 
Scientific  management,  64,  104 
Seigniorage,  175 
Selling  bureaus,  110 
Shop  steward,  378 
Silver  dollars,  179 


454 


INDEX 


Socialism,  426,  et  seq. 

objections  to,  440 
Society  dynamic,  not  static,  424 
Speculation,  311 

control  of,  318 
Standard  of  living,  361 
Standard  wage,  380 
State  Socialism,  438 
Statistics,  304 

Stock  exchange  speculation,  314 
Stocks  and  shares,  312 
Strikes,  384 
Supply  curve,  140 
Supply,  demand  and  price,  129 

law  of,  137,  et  seq. 

Taxation,  equality  of,  401 

revenue  and  protective,  287 
Thriftlessness,   a   cause   of   poverty, 

347 

Time  wages,  364 
Token  money,  177 
Trade  acceptance,  250 
Trade,  early,  78 

marks,  153 

nature  of,  247 

union  methods,  384 

unions,  374 


Transport,  cost  of,  264 
Trusts,  112 

Unemployment,  345 

Union  label,  387 

United   States    Shipping    Board. 

419 

Utilities,  44,  52,  53 
Utility,  diminishing,  122 

marginal,  123 
Utopians,  424 

Value,  definition  of,  120 

intrinsic,  125 

in  use,  163 
Velocity  of  circulation,  183-184 

Wages,  iron  law  of,  358 

and  labor  cost,  302 

method  of  payment,  J5G4 

real,  362 

War,  lessons  of,  415 
Waste,  101,  432 
Wealth,  causes  of,  335 

consumer's,  60 

definition  of,  42 

incentives  to,  348 
WTork,  incentives  to,  351 


M     000027415     9 


